A shadow cast on China’s progress.
Investors pay the price
FAnimal Spirits or a communist country, China has done a lot of things right economically. Over the past three decades, it has liberalized the domestic economy and opened up the borders for trade, helping to lift hundreds of millions of citizens out of poverty (per capita GDP has more than tripled since 1980) and creating a global powerhouse.
But this transformation has not always gone smoothly, to say the least. And it may well get a lot rougher if what’s happening in China’s stock markets lately is any indication.
China’s two major exchanges — Shanghai and Shenzhen — on Monday lost 8.5 and seven per cent, respectively. It was the largest one-day selloff in Shanghai since 2007, but the markets have been reeling for some time.
What’s happened in China might be severe, but it’s no more severe than what has happened on a quasi-regular basis in stock markets around the world. Simply put, a bub- ble has deflated. That’s what happens to bubbles.
Yet since markets started falling in mid-June, Beijing has sought to shore up stock prices with a multi-pronged assault of intervention. A longterm investor might wonder if the cure is worse than the disease.
On June 12, the Shanghai composite was up nearly 60 per cent on the year; the smaller Shenzhen was up more than 120 per cent.
There wasn’t really a good fundamentals-based reasoning for that run-up. It was driven by liquidity, as investors — many of them small retail investors, encouraged by dovish monetary policy and official government pronouncements about the wisdom of investing in stocks — piled into the game.
And then the bubble burst, for about as much reason as it went up in the first place (i.e., not very much). In three weeks, Shanghai plunged by more than 30 per cent, Shenzhen by nearly 40 per cent. Chinese investors lost trillions.
Stocks were still up about 70 per cent year-over-year as of mid-June, but Beijing stepped in with heavy boots.
It allowed hard-hit companies to halt trading; at one point, more than half of Shanghai-listed stocks were frozen. It limited sales by insiders. It banned short-selling. It encouraged would-be issuers to “voluntarily” delay their IPOs. It put down-limits on stocks.
It was assisted in all this by the central bank, which in late June cut its rate — the fourth time since November — in a clear attempt to shore up investor confidence.
All of this was accompanied by a full-on public relations campaign. In official and quasi-official communications, “stability” and “confidence” are the words of the day. (A statement from the Association of Chinese Asset Managers on June 30 in the midst of the selloff cheerily predicted “sunshine will follow rainy days.”)
It’s easy to see why Beijing is so interested in protecting its markets. Unlike the West, retail investors comprise a big portion of stock market participation. Everyday Chinese — or at least the hundreds of
Policy, not fundamentals, is driving Chinese stock markets
millions wealthy enough to invest — have been losing their shirts, and a full-on meltdown could lead to all kinds of political headaches for the government.
For a time, the intervention worked. Then it didn’t.
Markets on Monday tumbled precisely because of fears that the central government would pare back its price support. Policy, not fundamentals, is driving Chinese stock markets.
If that sounds familiar, it should. Investors in the West are not above sucking at the government teat in the face of a crisis. But the kind of direct gerrymandering Beijing has undertaken is unprecedented by any measure. And it comes with a basket of risks for investors.
There’s the basic risk that the interventions just won’t work and panic will ensue anyway; billions of yuan will have been wasted.
There’s valuation risk, because China’s recent market distortions make it well-nigh impossible to accurately value stocks — which was a difficult enough task anyway, given the lack of transparency in Corporate China.
There’s significant added capital risk, too, thanks to trading controls. Western investors have been exiting China over the past few weeks for fear of getting their investments locked up.
Then there is the overriding problem with governments playing these confidence games: at a certain point, they have to turn off the taps of support. What happens then? We got a taste of the answer on Monday.
Yet there’s something more troubling, at least to those long-term investors who have watched the gradual maturing and liberalization of Chinese markets over the past few years.
Chinese regulators had been inching toward more open access to mainland markets, and had introduced a number of reforms (for instance, on margins and shortselling) that would bring them into the international fold.
A good sign of that evolution was the near-inclusion of Chinese A-Shares by the MSCI Emerging Markets index earlier this year.
That evolution has now been diverted. We should hope it has not been derailed.