The Chinese equities meltdown and the state of global bourses
There are important lessons to be learned from the stock market crash in China. What some thought was a market correction actually carried more ominous undertones giving evidence of a slowing economy. So how well are markets now recovering and what are the wider implications of the crash?
All eyes on China as equities collapse takes root
When the Shanghai Composite index suffered an 8.5% decline in a single day – the worst drop in eight years – the world panicked. Prior to the equities slide, China’s economy appeared on track for an annual GDP growth rate of 7%. Now it’s growing at its slowest rate in 25 years. As the world’s second-largest economy with an insatiable appetite for raw materials, copper, crude oil and natural gas, few people believed that a collapse was imminent.
The authorities in Beijing instinctively defended the performance of the Chinese economy, citing a dramatic change of focus in strategy from an export-driven market to a consumer-centric economy. The Chinese economy was not structurally cracked; it was merely changing direction according to the authorities.
But the numbers don’t lie. The Shanghai Composite index suffered its worst single day of trading, given the maximum permissible limit that stocks could fall. The day became known as Black Monday, but not the Black Monday of 1987 when the Dow Jones suffered a 22% decline before shutting down. The most dramatic effects of the Chinese meltdown were seen in emerging market economies like South Africa, Brazil, Malaysia, Venezuela and others.
The currencies of these countries have taken a pounding as investors cut short their plans for emerging market economy prospects. With weak Chinese demand, global prices for commodities began plunging. Since emerging market countries are the primary producers of many of these resources, their industries, bottom lines and employment prospects began to taper off. This has been reflected in the currency exchange cross rates with the rand, real and ringgit leading declines.
No commodities are safe in the downward spiral created by China’s equities collapse. Since 11 August 2015 an estimated $5 trillion has been erased from global equities markets. And what precipitated the equities slide in China is a mixture of elements: Chinese growth has declined alongside falling global demand, the Chinese currency has not helped matters, and a 2% devaluation sent markets into further turmoil.
Monetary policy tightening in the US has led to decreased capital injections into emerging market economies, which in turn leads to disappointing data. A strong US dollar has made it more difficult for foreign countries to buy dollar-denominated commodities, as more local money has to be spent purchasing the same quantity of commodities. But bear in mind that the Shanghai Composite is still up over 40% for 2015 – few markets can claim such a return. And since just 15% of Chinese households are invested in equities, the broader impact is limited. The Chinese tend to prefer property holdings which are a lot more stable than equities.
How should traders react to China’s decline?
First of all, what happens in China is significant to the rest of the world. Ignore this fact at your peril. 15% of the world’s gross domestic product comes from China, and 50% of global growth is Chinese. The Chinese economy is in the process of being rebalanced, and the government has taken various measures to stabilise the economy.
These include a devaluation of the CNY, large-scale purchases of blue-chip stocks, relaxing regulations to facilitate trading, selling foreign currency reserves to prop up the local currency, preventing 5%-or-more equity stakeholders from selling positions for a minimum of six months, going after rogue banks and financial institutions that are allowing capital flight from the Chinese economy, and various other measures.
Traders have taken a cue from fund managers who are now limiting their exposure to Asian equities, particularly Chinese stocks. We now face a situation where the world’s developed economies are dragging the rest of the world along. However, European recovery efforts are also weak, and American economic exceptionalism is on the decline. We are also fast approaching a time when the Fed will hike interest rates, thereby drawing further attention to the USD.
An interest-rate hike will cause the US dollar to appreciate, and lead to further downward pressure on emerging market currencies and their economies. China in particular will suffer with the rate hike in the US, as commodities prices will be relatively more expensive. As a trader, you will be seeing high levels of volatility in the week leading up to the FOMC meeting on September 16-17.
Weakness in equities will persist on a global scale as long as the likelihood of a rate hike remains at the forefront of traders’ minds. Interest-rate hikes tend to depress equities markets because company profits decline when the cost of long-term loans becomes more expensive. And since China has a Purchasing Managers’ Index well below 50, the economy has clearly contracted. This is a worrying sign, as it confirms the structural cracks that Beijing has been trying to deny.
Volatility is a fact of life – we all have to contend with it
The Chinese have been hard at work searching for scapegoats, but there are none. Market manipulation has been blamed for $5 trillion in losses for shareholders. The authorities also forced brokerages to add $15.7 billion to the stock market rescue fund and the People’s Bank of China slashed interest rates for a fifth time in ten months. The government has been encouraging novice investors to plough their money into the stock market, many of them borrowing for this purpose.
But the credit-fuelled rally could not last, and the government had to try and bail the stock market out. Even with these market corrections, Chinese equities are still overvalued and companies on the Shanghai Composite are an estimated 50% more expensive than those of the S&P 500. We can also expect the CNY to decline further as more evidence of a slowing economy is brought to bear. The Chinese government does not deal well with volatility and the downside thereof, but it is a reality in global markets with which we all have to contend.
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