by Tom Stevenson, Investment Director at Fidelity
January 2016
Well here we go again. Just as they did last year, China’s volatile stock markets have spooked investors all around the world. It’s been a shocking first full week of 2016 and a worrying portent of returns for the year as a whole if you believe the moderately compelling long-run evidence that January sets the tone for the next 11 months.
The key question, though, is whether investors in the rest of the world have over-reacted. I think there are good reasons to think that Shanghai is punching above its natural weight as far as global investment sentiment is concerned.
The gloomy reading of the turmoil is that we are witnessing the third wave of the deflationary slump that started in the US housing market in 2007, moved into the eurozone in 2011 before enveloping emerging markets a couple of years ago. According to this view of the world, the slide in China’s shares and currency heralds a further reduction in demand for commodities and traded goods and will lead to another downturn in global output.
The less-gloomy assessment of the slide in Chinese equities is that it is just unfinished business from last year’s partial deflation of the 2014-15 A-share bubble, and as such a purely domestic affair. The 45% slide in China’s stock market around mid-year just gone was painful but it still left Shanghai and Shenzhen up on the year. A proper purge was prevented by government intervention as the authorities used the so-called ‘national team’ of state-owned brokers to engineer a 30% rally in prices between August and December.
The main trigger for the recent slide seem to have been an expected lifting of a ban on sales by major shareholders rather than any real concern about what is happening in the Chinese economy. Profit taking after the August-to-December rally and anticipatory selling ahead of that relaxation was then accentuated by new market circuit-breakers. These were designed to calm trading but achieved the precise opposite as investors rushed to sell before markets closed for the day.
The authorities in Beijing are learning the hard way that markets work best when they are left to their own devices. The consequences of intervention tend to be unintended and unwelcome.
The truth about the Chinese stock market is that it is largely uncorrelated with the Chinese economy. When the stock market doubled in the year before last year’s rout, no-one seriously thought that the outlook for China was improving. It is unrealistic therefore to think that the bursting of that bubble should have anything more meaningful to say about the outlook for economic activity.
What we know about Chinese GDP is largely unchanged. The country is slowing down but it is not grinding to a halt. The old-economy, northern industrial heartlands are in bad shape while the coastal, service-sector new economy remains strong. Both China’s bulls and its bears tend to focus on one or other of these stories and extrapolate the evidence to the whole country. It’s a bit more nuanced than that.
The transition from an export and investment-led economy to one driven by domestic consumption is happening but it’s not a smooth process. There are going to be bumps along the way.
Stepping back from China, investors in the rest of the world, may come to be grateful for the popping of the Shanghai bubble. That’s because of two silver linings to the China crisis. First, the price of oil and other commodities is likely to remain low this year. The boost to consumption in net energy importers has been notable for its absence as households have chosen to rebuild their personal balance sheets. Car sales on both sides of the Atlantic suggest the appetite to spend may be returning.
Second, the Federal Reserve’s aspiration to raise interest rates four times this year may start to look like wishful thinking if markets remain volatile.
