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Why Chinese stocks just took a massive nosedive

June 26, 2015, 12:37 PM UTC
China Stocks Close Higher Friday
HAIKOU, CHINA - DECEMBER 05: (CHINA OUT) Investors watch the electronic board at a stock exchange hall on December 5, 2014 in Haikou, China. Chinese shares close higher Friday with the benchmark Shanghai Composite Index up 1.32 percent, or 38.19 points, to end at 2,937.65. The Shenzhen Component Index finished at 10,067.28 points, up 37.45 points, or 0.37 percent. (Photo by ChinaFotoPress/ChinaFotoPress via Getty Images)
Photograph by ChinaFotoPress via Getty Images

China’s stock market bubble may finally be bursting.

Shares of Chinese companies plunged on Friday, in the worst drop in that country’s stock market in years. The dive may end the recent quixotic run in China’s market, which has soared this year even as China’s economy has gone through its roughest patch in years. Corporate profits have fallen.

China’s Shanghai Composite index dropped 7.4% on Friday. That would be the equivalent of a more than 1,300-point drop in the Dow Jones industrial average. The Shenzhen Composite, which is dominated by tech stocks, ended trading down 7.9%.

As always in market turns, it is unclear exactly what sparked the current sell-off. Some have pointed to the fact that regulators have recently been tightening rules on buying stocks with money borrowed from a broker, or “on margin.” Officials in China are particularly concerned about stock loans that have been coming from unregulated financial entities.

Excessive buying on margin has been linked to other stock market crashes. Margin lending is at an all-time high in U.S. markets.

Even with the recent losses, the Shanghai Composite is still up 30% so far this year. The Shenzhen Composite is up an astounding 77%, easily making it the best performing market in the world so far in 2015.