China: Worst Yet to Come

A day after shares in China plunged 8.8%, shares on the Shangahi Stock Exchange rebounded, with the index ending the day up 3.9% at 2,881.07.

But investors in Hong Kong say that the worst is still yet to come, and that the outlook for China's market remains overly optimistic. The Hang Seng ended the day down 2.46% at 19,651.51.

"Equities in China are still much more overpriced than people are admitting at the moment," says Sean Darby, head of Asian strategy at Nomura Bank in Hong Kong. "The Chinese pressure cooker is getting hotter. It hasn't tightened rates that much. There's closed capital account money flowing in and contracting liquidity."

The panic selling Tuesday was brought about by a series of events over the past few days in China that made local investors concerned over the sustainability of the recent bull run, says Michael Spencer, chief Asia economist for Deutsche Bank in Hong Kong.

Last week, the Chinese government announced it was cracking down on illegal share placements on the local stock exchanges and would probably raise interest rates as a result of higher-than-expected inflationary pressures, prompting local rumors about an equity bubble.

Less substantiated speculation going around trading floors in China at the moment include potential crackdowns on mutual fund investment, fluctuations in the capital gains tax rate and a change in leadership at the Chinese Securities Regulatory Commission.