In recent weeks all the financial news has been focused upon a solution for the Greek debt crisis. The referendum in Greece followed by the financial and political negotiations in Brussels, has keep this current Greek tragedy on the front pages.
However a bigger drama has been playing out while being virtually unreported in the UK until this week and that is the spectacular growth and then fall in Chinese stock markets.
The financial and investment implications of the events in Shanghai are far more important to the world economy than those of Greece. To put the economies in context, China has 20 cities that are bigger than the whole of Greece and an economy 40 times larger. The fall in Chinese share prices in June were 13 times the size of the Greek economy. The knock on impact of the Chinese stock market losing a third of its value is far more significant.
The rebalancing of the Chinese economy from investment and export driven towards domestic consumption is a key pillar of the Beijing reform programme. Part of this programme was the ongoing promotion by the Chinese authorities of property and equity markets in order to create growth and a feel good factor within China. The outcome has been millions of inexperienced private investors pushing up Chinese stocks creating a bubble that has spectacularly burst. The Chinese government were encouraging equity investment right up to the point the market corrected. This has made policy makers look inept.
In August 2014, the Shanghai Composite Index stood at 2177 and by early June 2015 had grown 237% to 5166. Seven weeks later it stood at 3725 a fall of 28% including an 8.5% decline suffered on 27th July. This was the sharpest one day fall for eight years despite the Chinese government trying to support the market. This fall sent tremors around the global commodity markets and hit currency values.
Even with these recent falls the Shanghai Composite index is up 170% over one year and up 9.6% since January.
There is however concern that the Communist Party is losing control of their economy having stoked up a series of asset bubbles, first in residential property and then equities in order to keep up the pace of economic growth. The Chinese stabilisation measures adopted since the first big sell off in June did not work. Commentators think that the Chinese authorities have put a lot of credibility on the line to shore up prices and this credibility has been damaged. The government has already bought $250 bn Chinese equities and has a credit line of $450 bn if necessary. They have also adopted measures to close the market, ban short selling and forced brokerage houses to buy stock. Unfortunately this is leading to a false market, building up unnecessary stress.
Clearly markets need to settle at levels that can be sustained on fundamental reasons which may well mean the Chinese State swallowing some heavy losses.
For the rest of the world the events in China have much bearing. China consumes 50% of global coal, 43% of industrial metals and 23% of world grain.
The dangers posed specifically by the Chinese stock market falls may well have been over stated. The main concern is the slowing of the real economy and the impact that a lack of Chinese spending is having on the rest of the world particularly the BRIC economies.
As it happens the Chinese stock market is not that significant in relation to China’s real economy as for decades the stock market has not mirrored the nations GDP growth. Only 1 in 30 chinese people own shares as compared to 1 in 7 in the USA. For all the 100 million stock broking accounts in Shanghai most are owned by the wealthy and who are unlikely to scale back spending due to stock market falls.
There is an inevitable slowing in the rate of growth as a result of China’s new higher level of development. The fall off from 14.2% pa GDP growth in 2007 to about 6.8% this year is in line with the experience of other Asian countries like Japan, Taiwan and South Korea.
However unlike most western countries, the Chinese authorities have plenty of options to support their economy. They have already cut interest rates four times so far this year but still have room to cut further if need be. Their current bank lending rate is 4.85% far higher than that of the West. The nation’s banks are still in public ownership and so if the economy were to weaken the authorities could instruct the banks to keep lending.
If China is to become a normal economy and realise its full economic potential then the share of the economy based upon private consumption needs to rise from the current 38%. In order for this to happen the share taken up by investment and exports will need to fall. This is a great challenge to Chinese Prime Minister Li Keqiang.
As and when China becomes a consumer society it will have a huge impact on the world. If we just consider tourism a growing industry for Chinese travellers. Currently travel out of China by the Chinese exceeds arrivals into China by 4 to 1 even though only 1 in 20 Chinese have a passport.
Ever since last autumn when Chinese stock markets were beginning their bull run, there have been warnings of a bubble. Having now corrected, fair value has been restored after the momentum speculation of millions of private investors. We feel that this new fair value could continue to grow for many years but not without some bumps along the way.
As stated before we remain cautious but invested in China as the consumer growth story despite its volatility remains the core investment case.