Answers, lessons about China's effect on the markets

BEIJING -- With the Chinese stock market turmoil that incited global panic abated -- at least for now -- here are questions and answers about it, as well as lessons to learn:

Why did the Chinese market drop so much?

China's main stock index tumbled nearly 23 percent over five days before returning to positive territory Thursday and Friday.

It had more than doubled over 12 months from June 2014 as state media encouraged the public to invest even after growth began to slow. That fostered expectations the government would intervene if needed to keep the market from falling.

By June, stocks were "trading at sky-high, rocket-crazy valuations," said Dickie Wong, executive director of research at Kingston Financial Group in Hong Kong.

Prices started to fall in mid-June after regulators tightened margin financing to limit the amount brokerages could lend to customers to trade shares.

That prompted concern authorities no longer would support share prices. As those fears spread, panicky investors dumped shares. The central bank's Aug. 11 devaluation of the yuan accelerated the declines by fanning concern the move would accelerate an outflow of capital from China, leaving less credit to finance stock trading.

Authorities responded with a flurry of measures to shore up prices, including barring big shareholders from selling and ordering brokerages and pension funds to buy. But those announcements confused small shareholders and fueled panic.

Why did investors react with so much alarm?

China is the world's second-largest economy and has been a key driver of global growth for years. Signs of a slowdown in China's economy emerged this year, but the market kept climbing.

So when the market began to slide in mid-June, global investors began to notice. When the drops worsened and Shanghai index tumbled 8.5 percent Aug. 24, that spooked international investors who already were worried about the possibility of higher U.S. interest rates, prompting a global sell-off.

As worries persist about global growth, "anything that suggests that the prospects look more dim is going to send equity investors running for cover," said Lori Heinel, chief portfolio strategist at State Street Global Advisors.

Is China's market an indicator of its future?

Not really. Chinese stock markets have little connection to the rest of the government-dominated economy. The biggest companies are state-owned, and their health is decided by official policy, not the market.

So traders respond to government cues and the availability of credit to finance speculation.

Stock prices can rise when the economy is weakening or fall though conditions are improving.

What can an investor learn from this?

For one, it's a reminder stock markets can swing wildly and should be viewed as long-term investments for people with a tolerance of risk. After an uninterrupted four-year rise by U.S. stocks, "I think people have forgotten that equity markets go down as well as up," said State Street's Heinel.

Another lesson is China's stock market has become big and closely watched. Although it's a poor indicator of China's well-being, and most of the world is shut out of it, investors need to know more about it.