The Chinese Stock Market

Ten days ago we had a request from a reader to write about China. Last week we felt that the situation had stabilised and chose to write about gold instead. So...

Why is China back in the headlines? 

On Monday the Chinese stock market, as measured by the Shanghai Composite Index, fell 8.5%. This is the second biggest one-day fall in its history. This is significant because for the past month Beijing has been on a campaign to support prices. This has included the use of some pretty aggressive measures such as banning IPOs (forcing investors to buy the shares of existing companies and hence supporting their prices), banning large shareholders from selling shares and using government money to buy shares.

Selling was steady throughout the day on Monday, after a data release showed that China’s industrial profits declined 0.3% year on year in June. Chaos then ensued in the last hour of trading after the IMF suggested that Beijing stop interfering in the markets and investors panicked that support measures would be withdrawn. China’s “national team” of state-directed investors have however continued to pile into equities and the market has recovered somewhat, albeit with on-going volatility.

Rollercoaster Ride: Shanghai Composite (orange) vs. the US’s S&P 500 (blue) over 1 year (Graphic - Bloomberg.com)

Rollercoaster Ride: Shanghai Composite (orange) vs. the US’s S&P 500 (blue) over 1 year (Graphic - Bloomberg.com)

Back up a bit...why was the government propping up the stock market?

The Chinese stock market has had a very volatile year. It was up around 60% at its 12 June peak, only to collapse by nearly 30% in a month. Commentators like to point out that around 80% of the stock market is owned by retail investors and that trading on margin accounts for 18% of the tradable value of the market - vs. less than 6% in New York and 1% in Tokyo (trading on margin involves using borrowed money to amplify gains...and losses). The situation is more complex than that. Nevertheless, China is moving from an economy that is driven by heavy infrastructure investment to one where the domestic consumer and services play a larger role. Having a stable stock market where individuals can invest and gain confidence from the rising value of their shares is an important part of that. Sceptics will also say that a booming market draws attention away from slowing growth and a stalled reform program.

Should I panic?

No, as one of our contacts pointed out, “the stock market is not the economy”. In fact, the stock market currently isn’t even that important to the economy. Less than 7% of urban Chinese have any money in the market (vs. 50% in the US) while equity raising counts for less than 5% of total corporate fund raising. Investments in property and funding from bank loans are much more important. Not surprisingly then, recent macroeconomic policy has focused on stabilising a weak property market and supporting investment growth through cautious monetary easing. The economy itself is ok. Growth in the second quarter was bang on target at 7%. This is a big number, even if it was massaged a bit. China is Africa’s largest trading partner and in 2011 it imported nearly US100bn of crude oil, raw materials and resources from Africa. Trade between Africa and China is nearly double that of trade between Africa and the US. Nearly half of China’s cumulative foreign aid has been given to Africa. China is therefore crucial to Africa, if the economy crashes, then it will be time to be concerned.

(Sources: Brookings Institute, Zero Hedge, CNBC, Bloomberg, FT, personal conversations) 

DR ANDREW LOUW CFA