If the behavior of stock markets were logical, we could all make a killing, but they seem to be largely driven by fear, gut-instinct, rumour and the herd mentality. If one looks at the progress of the main Chinese stock exchange, the Shanghai Stock Exchange, over the time window from January 2014 to date, you’ll see that values have leapt from a level of 2117 to a peak of 5166 (this June). They have “collapsed” back to a value of 3230 currently. So even with all of the current anxiety following a 40% decline since the June peak, the index is still up by 52.5% in 21 months – not bad. In comparison, the Dow Jones has made a whopping 0.3% over the same time period (16470 to 16528 with a max of 18272). In short, the Chinese stock market crisis is nothing more than the deflation of a bubble that had little business inflating so much or so fast.

However, markets are not logical. The news, therefore, that the official Markit Purchasing Manager’s Index (PMI) reading for China has slipped to 49.7 for August, implying a contraction, from a neutral reading of 50 in July will generate fresh negative sentiment. Clearly, this means that the dawning of the economic apocalypse is nigh…

Then again, it has been evident for a long while that the Chinese economy is slowing. In part, of course, this is because demand from China’s export markets, notably the EU, USA and Japan, remains subdued as the world still tries to shake of lingering effects from the global financial crisis.

China may be about to learn a lesson that central banks have known for quite some time now – markets are too large to successfully manipulate over the longer term. Chinese decisions to allow pension funds to invest a limited amount of their capital (up to 30%) in the stock market and a reduction in the central bank interest rate only provided temporary relief to the slide in the index’s value.

The poorer news from China is having the predictable knock-on effect in markets further afield as Bearish sentiment prevails. It is likely that this will continue until markets are calmed with better economic data or, more probably, investors return to the markets to pick up cheap(er) stocks.