The Great Fall of China?

Tumbling stock markets around the world have triggered a resurgence in the debate about the sustainability of China’s economic performance. So what does the future hold?

  • China broken map.jpg

Chinese intervention to prop up the Shanghai stock exchange has fuelled speculation about economic growth running out of steam and after failing to slow the rout the authorities have stepped back.

So, is this a conventional market correction with prices running ahead of fundamentals, or something more serious?

My view would be it’s a technical market correction. Here’s why:-

Investment into Chinese mainland markets, already strong, was further buoyed by the Stock Connect “Through Train” at the end of 2014, giving Hong Kong based investors access to the Shanghai market and vice versa, but the early flows were nearly all inbound, as investors chased the China growth story.

Recent news of a moderating in economic growth (already planned by the authorities due to concerns about asset bubbles) saw the Shanghai exchange retreat by 30% propelled by investors fears around their highly geared holdings. Almost nothing is guaranteed to induce instability in stock markets more than watching prices fall below the value of loans used to pay for them.

The Chinese authorities have an interventionist record, it is after all a social market form of capitalism, but markets are not a mathematical laboratory, and it seems China has conceded that the wall of cash needed to prop up an entire market when the world is watching, is beyond any single country. Investors used to seeing share prices propped up, have panicked.

China is transitioning from a double digit high growth emerging market to the world’s leading economic power, and the Chinese authorities had already signalled a move to a more sustainable growth trajectory to head of price bubbles. The current market gyrations are part of the transitioning to this new economic state and will allow a reset of valuations to more sustainable levels.

However, the China growth story is still intact.

The recent renminbi devaluation will make Chinese exports more competitive and kickstart the economy. In 2014, China overtook the US in terms of world GDP ( just over 16%) and now has a bigger share of trade with more countries than the US. If China does decide to intervene in markets, it has enormous firepower, with reserves of some $3.7trn. Speculators will now be less confident of automatic market support and this should dampen volatility.

Governance is improving dramatically, Xi Jinping’s anti corruption drive has seen more than 600,000 officials disciplined or indicted, rooting out corruption, and strengthening Xi's hold on power, as the Chinese people see action on one of their biggest concerns.

Chinese economic performance is not all about domestic share values. With more than $20bn invested in Africa each year and the launch of the Asian Infrastructure bank, Beijing has signalled its global ambitions, and will continue its inexorable march to No 1 world economy status.

Global stock markets have been inflated by Central banks ultra low interest rate policies and unless there is some policy intervention, then prices will need to go lower to bring prices back in line with market fundamentals.

With the FED predicted to move on interest rates sooner rather than later, and the liquidity prop of QE gradually removed, the inflation of markets by public policy measures appears to be coming to an end. We can expect a bumpy ride to the new normal, but this doesn't alter long-term fundamentals. China will not fall and it's resilience will surprise on the upside.

 

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