Is the Chinese Economy Really Going into Meltdown?
82% of the top 100 mutual funds are China funds!
Streets of Shanghai
Mired in Speculative Doubt the Chinese Economy Bucks the Bears
The Shanghai Composite has been one of the world's most keenly watched bourses for obvious reasons. As home to the world's biggest commodities consumer, China is front and centre in the financial world. Earlier in July 2015, tongues were wagging about the abysmal performance of the Chinese stock exchange. However it should be remembered that China's stock market does not function along the same lines as Western stock markets. The amount of direct intervention by the Chinese government in the stock market goes beyond substantial, and this has already been proven with the measures adopted by the government in recent weeks.
For example, all tentacles of the state can be utilised to prop up, stabilise and boost the performance of the Shanghai Composite. These include ordering brokerage companies to purchase billions of dollars’ worth of shares, freeze IPOs, prevent investors with more than 5% holdings in companies from selling their shares for a period of 6 months, curtail pension funds from jeopardising market stability etc. But beyond that, the Chinese government has also relaxed regulatory measures to make it easier for investors to access capital with which to buy shares. Another critical fact should be pointed out about the Chinese stock market and the average Chinese household: approximately 15% of Chinese households are invested in the stock market.
When forming an opinion about the state of the Chinese economy, a good way to do this is to compare the Chinese stock exchange with something like the S&P 500. The latter index is a fantastic barometer of the state of the US economy. Recall that the massive spike in the Shanghai Composite from July 2014 through June 2015 was not accompanied by expanding levels of economic activity across mainland China. By the same token, the Chinese economy did not contract substantially when the Shanghai Composite plunged by over 31% in June and July. And the reason why the Chinese stock market performance is unlikely to impact on broader Chinese economic activity is due in part to the macroeconomic objectives that have been implemented by the Chinese government. In recent years the Chinese economy has been focused on export driven growth, but in the past three years the Chinese government has been focusing on building up its domestic economy. And it is for this reason – a change of economic focus – that the burgeoning Chinese middle class is driving manufacturing, production, and strong consumer sentiment
Shanghai Stock Exchange Area
The Shanghai Composite Index and the Balance of Trade
But there is still a lot of work to be done to resuscitate confidence in the Chinese stock market. In order to keep sentiment positive, the provision of credit must be ensured. Government intervention in the operation of the financial markets is also a thorn in the side of economic growth and prosperity. A graphic of the Shanghai Composite index paints an interesting picture for analysts. The index performed at extraordinary levels leading into the 2007/2008 financial crisis. By that stage the Shanghai Composite index was trading marginally above 6,000 at 6092.05 index points - a level it has never seen since. In the past year, the Shanghai Composite index flat-lined at the 2,000 mark until around October 2014. From March through June the Shanghai Composite index rallied as high as 5,200, before a precipitous decline to the current level around 3,750. In the years from 1990 through 2015, the Chinese stock market averaged 1757.09 index points.
The Shanghai Composite monitors the performance of A-shares + B-shares that are listed on the Shanghai Stock Exchange. The base value of the index (as of December 19, 1990) is CNY 100. An important determinant of economic performance for a country is the balance of trade. In China, the balance of trade has been in surplus for the last year; however since May 2015 the surplus has been declining. From 1983 through 2015 the balance of trade in the country has averaged $72.04 billion. The only times in recent history that the balance of trade plunged into negative territory was in 2012 and 2014. In the six years between 2004 and 2009, China has recorded 10 increases in its trade surplus. However, a slowdown was evident in the 3.4% growth in trade throughout 2014 – well below the targeted range of 7.5%. The biggest trade deficits were recorded with Germany, Taiwan, South Korea and Australia, while large trade surpluses were recorded with countries like the UK, Hong Kong, Netherlands, Vietnam and the US. As of May 2015 (reference point) the actual value for the balance of trade in China was $59.488 billion. For June 2015 the balance of trade surplus was $46.54 billion, and for July 2015 the balance of trade was $43.03 billion. Economists are anticipating $43.03 billion for August and $40.02 billion for September – clearly pointing to a downtrend in the Chinese balance of trade.
What Does this Data Mean for Investors?
Recall that the world's top 100 performing funds are heavily dominated by China funds – 82% of them. These mutual funds typically return 20.5% across-the-board, and they beat the China index. While Chinese stocks have plummeted 30% in the past two months (June through July), further declines have been arrested by regulatory policies implemented by the Chinese government. Since short selling has been blocked, further declines in stock prices have been avoided. The majority of trading in the Chinese stock market is through individual investors who tend to avoid funds. Despite plunging Chinese equities, scores of individual equities have emerged as the world's best performing stocks owing to bullish performance earlier on in 2015. Combined, the Shenzhen Stock Exchange and the Shanghai Stock Exchange are valued at $8 trillion. And according to Thomson Reuters – equities have returned 100% to their owners this year. It is likely that the focus will shift from small cap stocks to medium-large cap companies, following a period of consolidation in the market.
There have been several notable developments of late, including a rise in the price of ferrous scrap – the very first since October 2014. 6 mm heavy melting scrap was trading at $208 per metric ton on Friday, inclusive of 17% value added tax. This was up $16 per metric ton week-on-week, and deliverable to Zhangjiagan, Jiangsu province. Recall that commodities prices across the board have been declining on the back of oversupply and weak global demand. China has played a big part in declining global demand since it is the world's biggest consumer of commodities like crude oil, copper and iron ore. With the 8.5% shock drop in the Chinese equities markets in July, speculators came out in full force – shorting Chinese stocks across the board. This led to a knock-on effect in the commodities markets, driving prices further into the red.
Alibaba Group Headquarters
One of the biggest stocks to decline is Alibaba Group Holdings Ltd – the Chinese online retailer. Traders will recall that CEO of Alibaba – Jack Ma - wanted his company to be bigger than Amazon, when it started trading in the US. Alibaba (BABA) has been declining for 8 consecutive days (By August 8, 2015), amid bearish prospects for the Chinese economy. In New York, the stock was trading at $77.99, marking the longest decline since it debuted in September 2014. Of equal concern to traders and investors is weak manufacturing data coming out of China. This period is the slowest economic expansion in China in 25 years. Alibaba was selling American depositary receipts (ADRs) at $68 each in September, and by November they were selling at $119.15 each. By June 2015 a profit of 34% was reported – 46% lower year-on-year. The PMI in China for July was 50 – anything below 50 is considered contractionary.
The Declines are declining which is a Positive Sign for China
Based on all of the facts and figures, it is clear that the Chinese economy is trending lower. The GDP target range of 7% - 8% may need to be revised downwards on the back of the massive sell-off on the Shanghai Composite and declining sentiment coming out of China. Additionally, global investor sentiment by way of speculators is negative for 2015. But since 85% of Chinese households have absolutely nothing to do with the stock market and there is a rising middle class in China – the buying potential of over 1 billion people is substantial. Government intervention is capable of arresting further declines in equities markets and propping up the Chinese economy far better than most countries are able to do. Even though China is considered a command economy, it hardly follows that type of model. As long as the government keeps buying blue-chip stocks and props up the market, further sharp losses are unlikely. There may also be easing on the cash stockpiles banks are required to hold in the upcoming months. This is part of a monetary policy designed to accelerate the velocity flow of money through the economy.