The China syndrome - What's next?
Although the troubles in Greece’s economy have been the main event in global share markets in recent times, there’s a more pressing worry in international markets that’s closer to home.
The past couple of months have seen the Chinese share market lose more than 20 per cent of its value, which equates to around US$2 trillion. As it is Australia’s largest trading partner China’s fortunes have a range of implications for investors.
China has seen extraordinary economic growth over the past 20 years, driven by aggressive investment in infrastructure and population movement to urban areas.
The stock market, however, has been volatile over this time. It underwent one boom-bust cycle between 2006 and 2009, with share values rising five-fold between 2006 and 2008, before most of those gains were lost. The stock market was then relatively subdued until late last year when it started bubbling again.
Before 2006, Chinese households directed most of their investments towards the property market. But this focus shifted to the equity market when the government introduced measures to curtail property investment.
Today, the renewed interest in the stock market again reflects a switch out of the property market by households. There is also a perception the government has supported the stock market by allowing more trading accounts and margin lending.
These factors have seen retail investors in China dominate the share market. This is in contrast to share markets in other countries, which tend to be led by institutional investors.
This is an important consideration given retail investors tend to speculate more than institutional investors and have a poorer understanding of what they are investing in, which can make for a more volatile market.
The current situation
As the share market rose rapidly thanks to the flood of retail investors entering it, the Chinese government became concerned about the potential for a bubble and introduced measures to control it. Here are some examples:
January
- Minimum amount of cash required to trade on margin loans was raised.
- Strict enforcement of margin trade regulations.
April
- Ban introduced on brokers helping clients to evade limits on margin trading using specially designed financial products.
June
- Volume of margin lending stock brokers can do limited.
- Ban on using financial products to get around the limits on margin trading reinforced.
The Chinese share market has rapidly declined following the introduction of new regulations. There has been a trickle-down effect to other markets, with commodities in particular affected by the Chinese share market sell down.
Government intervention
Following the decline of the share market, the Chinese government responded by introducing a number of interventions to restore share market confidence.
One of the most significant initiatives has been a $US42billion investment by the Chinese government in the share market via brokerage firms. This has been in addition to the Securities Association of China pledging money to invest in the Chinese market. In addition, the government reduced the official cash rate to encourage borrowing to invest in equities.
On top of this, China reduced limits on margin lending and allowed investors to use their houses as collateral for investing in shares. At the same time, a cap was introduced on short-selling of shares to help reduce the downward trend. Additionally, pension funds and social security funds have been encouraged to invest more money in shares.
Other temporary measures
There have also been other measures introduced on a short-term basis to help support Chinese share prices. For instance, a number of new initial public offerings have been postponed and companies have also been allowed to suspend trading in their shares. To stabilise the market the government also ordered all large shareholders with stakes of more than five per cent in a company not to sell their shares for up to six months.
These measures have not completely stemmed the flow of funds out of shares. But there are tentative signs the downward trend is slowing and China is likely to continue to introduce new measures until the market does stabilise. This is because it recognises fully functioning capital markets are critical to the country’s economic outlook and further development.
Implications of intervention
If the Chinese government is successful in managing the slide in the share market, in the short-term volatility across markets should ease and commodity prices should recover, which will benefit Australia. Longer term, the support measures will need to be rolled back otherwise they could eventually cause another surge in the equity market.
If the Chinese government is not successful in managing the slide in the share market, volatility globally is likely to remain elevated as investors seek safe assets. This sort of market can be challenging. But it can also create opportunities for alternative investment strategies. It might also produce buying opportunities for bluechip shares whose prices have fallen with the market.
However, it’s worth noting Bloomberg’s figures for July indicate the Chinese share market has risen by more than 80 per cent compared to 12 months ago. So the current downturn could be a correction to true value, and the market may begin to stabilise from this point.
It’s important for investors who wish to gain exposure to the Chinese market to seek advice before taking a decision to invest. So talk to us today about the dynamics of the Chinese market and how it could impact your portfolio over the short, medium and long-term.
