What China’s stock turmoil means for SA
Cooling economy creates local worries
CHINA is likely to be a greater threat to South Africa’s economic prospects than the crisis in Greece, especially if its collapsing stock market erodes Chinese retail investors’ wealth.
The potential for damage to South Africa’s economy lies not so much in a sharp fall in stock prices in the Shanghai and Hong Kong stock markets, because despite the decline, Chinese stocks are still 100% up over the past year alone.
It is important for South Africa that China avoids a protracted and more severe pullback that affects the wealth of its retail investors.
That could imperil its attempts to create a consumption-led economy as it weans itself off infrastructure projects and real estate as growth drivers.
FNB economist Alex Smith said that because Chinese state banks had offered historically low interest rates on deposits — the flip side of the government’s drive to lend cheaply to state-owned enterprises while building infrastructure — Chinese investors had tended to place their savings in sometimes risky equity investments to build wealth.
“If the market drops a lot more, there would be a negative wealth effect that would constrain Chinese consumption. Bear in mind there is a political dimension to this — the politicians don’t want a situation where large amounts of household savings are wiped out.”
With so much of the money invested in Chinese companies sourced domestically, the risk for South Africa is tied more to China’s economy, which is at its coolest since 2009, than to stock prices in that country.
“What we should worry about most is demand for raw commodities because China is our biggest export destination.
“The iron ore price has come off quite substantially in the last couple of weeks, and that seems to indicate market participants in commodities are concerned that market events A CLOSE EYE: An investor checks stock information at a brokerage house in Fuyang, China. The Chinese stock market is dominated by retail investors reflect a more fundamental and rapid slowdown in China’s economy than we were expecting,” Smith said.
“Given that iron ore is one of our big four exports and we’re dependent on it, this implies our terms of trade will come under further pressure if the price doesn’t recover. That has implications for the currency, monetary policy and economic growth.”
Neal Smith, a portfolio manager at Sanlam Investment Management’s global investments unit — which does not participate in the Chinese A share market but plays in H shares in Hong Kong — said attempted intervention by the Chinese regulator, which included suspending trade in some 1 300 companies in an attempt to stem selling, had damaged the country’s credibility in the midst of attempts to include its A share market in global capital markets.
“The top 20 Chinese companies, even after this correction, are still up 81% over the last year, and the worst 20 — really not very good companies — are down 64% and still up over the last 12 months. ”
FNB’s Smith said the Chinese regulator’s failure to let the market cleanse itself could lead to simply drawing out the downturn. Investors with leveraged positions whose debts are being called in will still have to sell when the moratorium is over.
The Chinese stock market is dominated by retail investors.
“Institutions play an important role in market mechanisms, particularly in providing liquidity when markets decline — they provide a buyer in this kind of situation. They can often be more attuned to the valuation metrics and if there had been more institutional investors, we might not have seen the market become so overvalued and driven up to such multiples in the lead-up to this miniature crash,” he said.
Sanlam’s Smith said the Chinese interventions had no hope of stabilising the market.
“From its peak in June to this week, 10-trillion yuan has been taken out of the market, which leaves the market capitalisation of the A share market at 42-trillion yuan, or 75% of GDP. With their measures they’ve invested a trillion yuan. That’s a drop in the ocean in attempting to build confidence back into the market.”
Ultimately, the US hiking interest rates should be of more concern to South Africa than China’s problems.
“Given South Africa’s dual deficits and geared balance sheet, we’re very vulnerable and dependent on capital flows. It’s hard to say how material the US interest rate hikes will be, though, because markets have started pricing that in already.”
Liang Du, head of balanced and China funds at Prescient Investment Management, agreed with Sanlam’s Smith that on the upside this represents a good buying opportunity in China.
“If markets are not irrational at times, there would be no opportunity to add value and add alpha for our clients. The recent correction is a good lesson for both Chinese speculators and regulators,” Liang said.