CHINESE INVESTORS MAY BE PANICKING, BUT IT’S NOT TIME TO JOIN THEM
Economy, market links appear weaker there than elsewhere, Joe Chidley writes.
It’s easy to find metrics for how badly Chinese equities are performing, but difficult to know where to begin. Maybe we’ll start with the four trading days in July so far: The Shanghai composite index is down nearly four per cent. Or maybe we’ll go with the past month — down 11.4 per cent. Six weeks? Minus 13 per cent. Or maybe since its 2018 high, in late January? It’s down a whopping 22.5 per cent since then.
Short story: The Chinese stock market is in bear territory, and seems to be heading deeper into it every day. The reasons aren’t hard to find, either.
There’s the rapid devaluation of the yuan against the U.S. dollar, by more than five per cent since mid-April, raising the spectre of a capital flight like the one back in 2015. (The Shanghai index lost more than 40 per cent that summer.) There’s troubling economic data, like slowing credit growth and, according to the June purchasing managers’ index (PMI), deteriorating export orders. And of course (and not unrelated), there’s the apparently escalating trade war Donald Trump started, which will reach a new milestone at the end of this week when some of China’s retaliatory tariffs against the United States go into effect.
So as fears of a big slowdown in China are mounting, the stock market is melting down. Or maybe it’s the other way round: As the stock market is melting down, fears of a China slowdown are mounting.
See the difference? The point is, as is so often noted by sages closer to home, the market is not the economy. And that goes double for China, where the stock market is different from just about every other big stock market on the planet.
For one thing, it’s dominated by retail investors, who account for more than 80 per cent of trades. In the West, retail action is a fraction of that. Citizen participation in stock markets is not a bad thing, especially in a country where the household savings rate is about 10 times higher than in Canada. But having 200 million or so retail investors as a dominant force does suggest that market volatility will be much higher, as sentiment is likely to play a larger role. And in fact, Chinese markets are historically volatile.
According to the Stern School of Business’s Volatility Lab, the Shanghai index’s average weekly volatility is about nine percentage points higher than the S&P 500.
The Chinese market is also heavily insulated from the perhaps-calming influence of international capital, which comprises only about two per cent of share ownership. (That is changing, but slowly.)
And finally, despite their popularity, Chinese equities simply don’t represent that big a chunk of the overall economy.
According to the World Bank, the market capitalization of publicly listed domestic companies amounted to just over 70 per cent of GDP in 2017. That’s far below not only the market cap-to- GDP ratio in Canada (143 per cent) and the U.S. (166 per cent), but also the global average (113 per cent). For investors, that comparison might make Chinese stocks look like a tempting opportunity over the long term, but it also suggests that the linkages between the economy and the stock market are even weaker there than elsewhere.
So what is going on in the economy? A slowdown seems imminent. GDP surprised to the upside in the first quarter, at 6.8 per cent, but economists are expecting a slower second quarter and an even slower second half. But consensus estimates are for around 6.5-per-cent growth for 2018. That would be the lowest growth since 1990, but hardly a disaster.
We should also remember that much of that slowdown is, if not intentional, then at least expected by the most important player in the Chinese economy: the Chinese government.
Its deleveraging initiatives, cracking down on shadow lending and non-performing loans, are taking a bigger bite out of growth expectations than anything Donald Trump has done so far on the trade side. And the government’s long-term desire to shift the Chinese economy from an export/manufacturing orientation to a consumption/ services one is (slowly) becoming a reality, but it also means less rapid, more sustainable growth.
But what if Trump’s trade war escalates? Most estimates I’ve seen put the worst-case impact on the Chinese economy at a shaving of somewhere between one and 1.5 percentage points of GDP growth. That could have huge ripple effects in China and across the global economy, as demand contracts. But again, it’s hardly a recession. To my mind, an actual recession is more likely in the U.S. in a couple years, should the trade war, along with the Republicans’ (completely unnecessary) fiscal stimulus, prompt the Federal Reserve to over-tighten financial conditions.
Compared with western policymakers, the Chinese government has plenty of levers to pull to fend off disaster. It has already pledged to stabilize the yuan. It could relax its deleveraging program to boost credit formation. It could spend some of the several trillions of dollars it has in reserves. It could even step in to buy up stock. And it doesn’t need congressional approval to do any of those things, nor will it have to face an angry electorate in two years.
I am not suggesting that all is well in the Middle Kingdom. The financial system is a big risk. The shift to a consumer-/servicesled economy is a delicate one. Lots could and no doubt will go wrong. When it comes to China and its growing importance to the global economy, concern is rational.
But fear isn’t.
Financial Post