The China crunch: Global market overreaction?

Investors endured a tumultuous ride on Monday, with most equity markets around the globe sustaining heavy losses. Since the global turmoil was led by a rout in China's market, some observers wondered whether the move was yet another overreaction to news from Asia.

China's Shanghai Composite dropped 8.5% Monday, its sharpest one-day drop since 2007, while the Dow Industrials closed the day with a 588.4-point decline.

Despite the startling numbers, Leland Miller, president of data analytics firm China Beige Book International, told Yahoo Finance that the drop is a “massive overreaction.” "We spent the last two months getting comfortable with the idea that China’s real economy is very different from the stock market; but once the U.S. stock market starts tanking, then China is to blame?” Miller says.

The People’s Bank of China is preparing for a third reduction in its reserve requirement this year, a move that will flood China’s banking system with liquidity – and ultimately, the central bank hopes – will encourage more bank lending.

Sri Kumar of Sri-Kumar Global Strategies says, “When the PBoC decided to devalue the yuan [on Aug. 11], we should have realized that the economy was in serious trouble.”

Global investors have grown increasingly frustrated by the lack of transparency from the Chinese government. Last month, the world’s second-largest economy confounded consensus expectations that its growth would slow further in the second quarter.  But China’s National Bureau of Statistics claimed that GDP rose 7% from a year earlier. This was a stronger-than-expected figure, beating a Reuters poll, which forecast growth at 6.9%. The median estimate of Bloomberg’s survey of 11 economists was 6.3%.

Indeed, China’s GDP seems at odds with other data points, like industrial production, which grew by 5.6% year-over-year in March, and is considered an accurate gauge of economic growth.

Economists see discrepancies between China’s official numbers and its actual growth, noting that the run-up won’t be sustained without further stimulus.

Will investors be able to regain confidence in the global markets? Only if we see data that confirm China is actually getting stronger.

“What will put a lid on the bottom will be an understanding that the Chinese economy is actually getting better,” Miller says. “What’s going on right now is purely trader anxiety.”

“This may be a precursor of what will happen in the U.S.,” says Kumar. “The PBoC is running ahead of the Fed and teaching the U.S. a lesson that it does not have full control." The U.S. Federal Reserve has been widely expected to raise interest rates in September, the first time it would do so since June 2006, but market uncertainty could change the Fed’s course.

Oh, the irony. China’s efforts to prop up the market have not only been futile, but are roiling the market it is trying to stabilize.