Don't Mistake China's Stock Market For China's Economy
Kenneth Rapoza
7/09/2015 @ 2:56PM
China’s A-share market is rebounding, but whether or not it has hit bottom is beside the point. What matters is this: the equity market in China is a more or less a gambling den dominated by retail investors who make their investment decisions based on what they read in investor newsletters. It’s a herd mentality. And more importantly, their trading habits do not reflect economic fundamentals.
“The country’s stock market plays a smaller role in its economy than the U.S. stock market does in ours, and has fewer linkages to the rest of the economy,” says Bill Adams, PNC Financial’s senior international economist in Pittsburgh.
The fact that the two are unhinged limits the potential for China’s equity correction — or a bubble — to trigger widespread economic distress. The recent 25% decline in the Deutsche X-Trackers China A-Shares (ASHR) fund, partially recuperated on Thursday, is not a signal of an impending Chinese recession.
PNC’s baseline forecast for Chinese real GDP growth in 2015 remains unchanged at 6.8% despite the correction, a correction which has been heralded by the bears as the beginning of the end for China’s capitalist experiment.
China’s economy, like its market, is transforming. China is moving away from being a low-cost producer and exporter, to becoming a consumer driven society. It wants to professionalize its financial services sector, and build a green-tech economy to help eliminate its pollution problems. It’s slowly opening its capital account and taking steps to reforming its financial markets. There will be errors and surprises, and anyone who thinks otherwise will be disappointed.
Over the last four weeks, the Chinese government misplayed its hand when it decided to use tools for the economy — mainly an interest rate reduction and reserve ratio requirement cuts for banks in an effort to provide the market with more liquidity.
It worked for a little while, and recent moves to change rules on margin, and even utilize a circuit-breaker mechanism to temporarily delist fast-tanking companies from the mainland stock market, might have worked if the Greece crisis didn’t pull the plug on global risk. The timing was terrible. And it pushed people into panic selling, turning China into the biggest financial market headline this side of Athens.
For better or for worse, Beijing now has no choice but to go all-in to defend equities, some investors told FORBES.
But China’s real economy is doing much better than the Shanghai and Shenzhen exchanges suggest. According to China Beige Book, the Chinese economy actually recovered last quarter. Markets are focusing on equities and PMI indicators from the state and HSBC as a gauge, but it should become clear in the coming weeks that China’s stock market is not a reflection of the fundamentals.
The Good, The Bad and the Ugly
To get a more detailed picture of what is driving China’s growth slowdown, it is necessary to look at a broader array of economic and financial indicators. The epicenter of China’s problems are the industrial and property sectors.
Shares of the Shanghai Construction Group, one of the largest developers listed on the Shanghai stock exchange, is down 42.6% in the past four weeks, two times worse than the Shanghai Composite Index. China Railway Group is down 33%, also an underperformer.
Growth in real industrial output has declined from 14% in mid-2011 to 5.9% in April, growth in fixed-asset investment declined 50% over the same period and electricity consumption by primary and secondary industries is in decline. China’s trade with the outside world is also falling, though this data does not always match up with other countries’ trade figures. Real estate is in decline as Beijing has put the breaks on its housing bubble. Only the east coast cities are still seeing price increases, but construction is not booming in Shanghai anymore.
The two main components of that have prevented a deeper downturn in activity are private spending on services, particularly financial services, and government-led increases in transportation infrastructure like road and rail.
Retail sales, especially e-commerce sales that have benefited the likes of Alibaba and Tencent, both of which have outperformed the index, have been growing faster than the overall economy. Electricity consumption in the services sector is expanding strongly. Growth in household incomes is outpacing GDP growth.
“China has begun the necessary rebalancing towards a more sustainable, consumption-led growth model,” says Jeremy Lawson, chief economist at Standard Life Investments in the U.K. He warns that “it’s still too early to claim success.”
Since 2011, developed markets led by the S&P 500 have performed better than China, but for one reason and one reason only: The central banks of Europe, the U.K., Japan and of course the U.S. have bought up assets in unprecedented volumes using printed money, or outright buying securities like the Fed’s purchase of bonds and mortgage backed securities.
Why bemoan China’s state intervention when central bank intervention has been what kept southern Europe afloat, and the U.S. stock market on fire since March 2009? Companies in China are still making money.
“I think people have no clue on China,” says Jan Dehn, head of research at Ashmore in London, a $70 billion emerging market fund manager with money at work in mainland China securities. “They don’t see the big picture. And they forget it is still an emerging market. The Chinese make mistakes and will continue to make mistakes like all governments. However, they will learn from their mistakes. The magnitude of most problems are not such that they lead to systematic meltdown. Each time the market freaks out, value — often deep value — starts to emerge. Long term, these volatile episodes are mere blips. They will not change the course of internationalization and maturing of the market,” Dehn told FORBES.
China is still building markets. It has a large environmental problem that will bode well for green tech firms like BYD. It’s middle class is not shrinking. Its billionaires are growing in numbers. They are reforming all the time. And in the long term, China is going to win. Markets are impatient and love a good drama. But investing is not a soap opera. It’s not Keeping up with the Kardashians you’re buying, you’re buying the world’s No. 2 economy, the biggest commodity consumer in the world, and home to 1.4 billion people, many of which have been steadily earning more than ever. China’s transition will cause temporary weakness in growth and volatility, maybe even crazy volatility.
But you have to break eggs to make an omelette, says Dehn.
Why The Stock Market Correction Won’t Hurt China
The Chinese equity correction is healthy and unlikely to have major adverse real economy consequences for several reasons:
First, China’s A-shares are still up 79% over the past 12 months. A reversal of fortunes was a shoo-in to occur.
Second, Chinese banks are basically not involved in providing leverage and show no signs of stress. The total leverage in Chinese financial markets is about four trillion yuan ($600 billion). Stock market leverage is concentrated in the informal sector – with trust funds and brokerages accounting for a little over half of the leverage. Margin financing via brokerages is down from 2.4 trillion yuan to 1.9 trillion yuan and let’s not forget that Chinese GDP is about 70 trillion yuan.
Third, there is very little evidence that the moves in the stock market will have a major impact on the real economy and consumption via portfolio loss. Stocks comprise only 15% of total wealth. Official sector institutions are large holders of stocks and their spending is under control of the government. As for the retail investor, they spend far less of their wealth than other countries. China has a 49% savings rate. Even if they lost half of it, they would be saving more than Americans, the highly indebted consumer society the world loves to love.
During the rally over the past twelve months, the stock market bubble did not trigger a boost in consumption indicating that higher equity gains didn’t impact spending habits too much.
The Chinese stock market is only 5% of total social financing in China. Stock markets only finance 2% of Chinese fixed asset investment. Only 1% of company loans have been put up with stocks as collateral, so the impact on corporate activity is going to be limited.
“The rapid rally and the violent correction illustrate the challenges of capital account liberalization, the need for a long-term institutional investor base, index inclusion and deeper financial markets, including foreign institutional investors,” Dehn says.
The A-shares correction is likely to encourage deeper financial reforms, not a reversal.
Kenneth Rapoza
7/09/2015 @ 2:56PM
China’s A-share market is rebounding, but whether or not it has hit bottom is beside the point. What matters is this: the equity market in China is a more or less a gambling den dominated by retail investors who make their investment decisions based on what they read in investor newsletters. It’s a herd mentality. And more importantly, their trading habits do not reflect economic fundamentals.
“The country’s stock market plays a smaller role in its economy than the U.S. stock market does in ours, and has fewer linkages to the rest of the economy,” says Bill Adams, PNC Financial’s senior international economist in Pittsburgh.
The fact that the two are unhinged limits the potential for China’s equity correction — or a bubble — to trigger widespread economic distress. The recent 25% decline in the Deutsche X-Trackers China A-Shares (ASHR) fund, partially recuperated on Thursday, is not a signal of an impending Chinese recession.
PNC’s baseline forecast for Chinese real GDP growth in 2015 remains unchanged at 6.8% despite the correction, a correction which has been heralded by the bears as the beginning of the end for China’s capitalist experiment.
China’s economy, like its market, is transforming. China is moving away from being a low-cost producer and exporter, to becoming a consumer driven society. It wants to professionalize its financial services sector, and build a green-tech economy to help eliminate its pollution problems. It’s slowly opening its capital account and taking steps to reforming its financial markets. There will be errors and surprises, and anyone who thinks otherwise will be disappointed.
Over the last four weeks, the Chinese government misplayed its hand when it decided to use tools for the economy — mainly an interest rate reduction and reserve ratio requirement cuts for banks in an effort to provide the market with more liquidity.
It worked for a little while, and recent moves to change rules on margin, and even utilize a circuit-breaker mechanism to temporarily delist fast-tanking companies from the mainland stock market, might have worked if the Greece crisis didn’t pull the plug on global risk. The timing was terrible. And it pushed people into panic selling, turning China into the biggest financial market headline this side of Athens.
For better or for worse, Beijing now has no choice but to go all-in to defend equities, some investors told FORBES.
But China’s real economy is doing much better than the Shanghai and Shenzhen exchanges suggest. According to China Beige Book, the Chinese economy actually recovered last quarter. Markets are focusing on equities and PMI indicators from the state and HSBC as a gauge, but it should become clear in the coming weeks that China’s stock market is not a reflection of the fundamentals.
The Good, The Bad and the Ugly
To get a more detailed picture of what is driving China’s growth slowdown, it is necessary to look at a broader array of economic and financial indicators. The epicenter of China’s problems are the industrial and property sectors.
Shares of the Shanghai Construction Group, one of the largest developers listed on the Shanghai stock exchange, is down 42.6% in the past four weeks, two times worse than the Shanghai Composite Index. China Railway Group is down 33%, also an underperformer.
Growth in real industrial output has declined from 14% in mid-2011 to 5.9% in April, growth in fixed-asset investment declined 50% over the same period and electricity consumption by primary and secondary industries is in decline. China’s trade with the outside world is also falling, though this data does not always match up with other countries’ trade figures. Real estate is in decline as Beijing has put the breaks on its housing bubble. Only the east coast cities are still seeing price increases, but construction is not booming in Shanghai anymore.
The two main components of that have prevented a deeper downturn in activity are private spending on services, particularly financial services, and government-led increases in transportation infrastructure like road and rail.
Retail sales, especially e-commerce sales that have benefited the likes of Alibaba and Tencent, both of which have outperformed the index, have been growing faster than the overall economy. Electricity consumption in the services sector is expanding strongly. Growth in household incomes is outpacing GDP growth.
“China has begun the necessary rebalancing towards a more sustainable, consumption-led growth model,” says Jeremy Lawson, chief economist at Standard Life Investments in the U.K. He warns that “it’s still too early to claim success.”
Since 2011, developed markets led by the S&P 500 have performed better than China, but for one reason and one reason only: The central banks of Europe, the U.K., Japan and of course the U.S. have bought up assets in unprecedented volumes using printed money, or outright buying securities like the Fed’s purchase of bonds and mortgage backed securities.
Why bemoan China’s state intervention when central bank intervention has been what kept southern Europe afloat, and the U.S. stock market on fire since March 2009? Companies in China are still making money.
“I think people have no clue on China,” says Jan Dehn, head of research at Ashmore in London, a $70 billion emerging market fund manager with money at work in mainland China securities. “They don’t see the big picture. And they forget it is still an emerging market. The Chinese make mistakes and will continue to make mistakes like all governments. However, they will learn from their mistakes. The magnitude of most problems are not such that they lead to systematic meltdown. Each time the market freaks out, value — often deep value — starts to emerge. Long term, these volatile episodes are mere blips. They will not change the course of internationalization and maturing of the market,” Dehn told FORBES.
China is still building markets. It has a large environmental problem that will bode well for green tech firms like BYD. It’s middle class is not shrinking. Its billionaires are growing in numbers. They are reforming all the time. And in the long term, China is going to win. Markets are impatient and love a good drama. But investing is not a soap opera. It’s not Keeping up with the Kardashians you’re buying, you’re buying the world’s No. 2 economy, the biggest commodity consumer in the world, and home to 1.4 billion people, many of which have been steadily earning more than ever. China’s transition will cause temporary weakness in growth and volatility, maybe even crazy volatility.
But you have to break eggs to make an omelette, says Dehn.
Why The Stock Market Correction Won’t Hurt China
The Chinese equity correction is healthy and unlikely to have major adverse real economy consequences for several reasons:
First, China’s A-shares are still up 79% over the past 12 months. A reversal of fortunes was a shoo-in to occur.
Second, Chinese banks are basically not involved in providing leverage and show no signs of stress. The total leverage in Chinese financial markets is about four trillion yuan ($600 billion). Stock market leverage is concentrated in the informal sector – with trust funds and brokerages accounting for a little over half of the leverage. Margin financing via brokerages is down from 2.4 trillion yuan to 1.9 trillion yuan and let’s not forget that Chinese GDP is about 70 trillion yuan.
Third, there is very little evidence that the moves in the stock market will have a major impact on the real economy and consumption via portfolio loss. Stocks comprise only 15% of total wealth. Official sector institutions are large holders of stocks and their spending is under control of the government. As for the retail investor, they spend far less of their wealth than other countries. China has a 49% savings rate. Even if they lost half of it, they would be saving more than Americans, the highly indebted consumer society the world loves to love.
During the rally over the past twelve months, the stock market bubble did not trigger a boost in consumption indicating that higher equity gains didn’t impact spending habits too much.
The Chinese stock market is only 5% of total social financing in China. Stock markets only finance 2% of Chinese fixed asset investment. Only 1% of company loans have been put up with stocks as collateral, so the impact on corporate activity is going to be limited.
“The rapid rally and the violent correction illustrate the challenges of capital account liberalization, the need for a long-term institutional investor base, index inclusion and deeper financial markets, including foreign institutional investors,” Dehn says.
The A-shares correction is likely to encourage deeper financial reforms, not a reversal.
Code:
http://www.forbes.com/sites/kenrapoza/2015/07/09/dont-mistake-chinas-stock-market-for-chinas-economy/
