Chinese Fears

BY: SHAAN FYE, EDITOR-IN-CHIEF

The turmoil in global markets was the dominant breaking news as I returned back to school. Throughout the summer, progressively more ominous signs of the deepening rut in the Chinese stock market appeared. China’s stock market woes spilled over to the rest of the world after the People’s Bank decided to devalue the currency by 2% against the dollar. This move indicated to investors that the central bank was seriously worried about China’s growth, considering it was the most dramatic drop in the past two decades. The devaluation, done in an attempt to boost exports, was a clear sign that the fundamentals of the economy were also worrisome. Additionally, over the past summer, the Chinese government has used its “national team” of large state-sponsored investors to inject over 200 billion dollars into the market through stock purchases. The government decided to cease using this method a few days ago; it now will focus on “punishing” those that apparently had spread negative information about the market. Jailing the shorts? Sounds like something any investor with exposure to China to be worried about nevertheless the people inside the country. China is looking increasingly desperate from the outside, but this isn’t quite the end of the People’s Republic as we know it, and investors around the world should not be nearly as concerned as the media would have them be based on the past several weeks.

Domestic Exposure

Assuming a Chinese market crash was more than just a temporary correction, the fear of dealing a blow to millions of Chinese consumers is overblown. According to Qu Hongbin, HSBC’s chief economist for Greater China, “The stock market wealth effect in China is smaller than many assume, as stocks represent less than 15% of household financial assets and equity issuance accounts for less than 5% of total social financing.” In layman’s terms, this means Chinese households are much less exposed to their own markets than Americans are, for instance. The Chinese are much more exposed to housing and real estate, a sector that has rebounded recently in China. So while a complete crash would significantly damage many households financially, the blast radius is limited. This view is furthered by the size of the market as a whole. Unlike developed stock markets, in which the total capitalization hovers around 100% of GDP, China’s is worth less than 40% of its GDP. This is assuming a worst-case scenario; many believe that the current declines are simply corrections of a overinflated bubble. In a market in which 80% of stock buyers are small, personal investors, there is room for extreme swings from less though-out trades. It is important to note that the Shanghai Composite is still, even after all the carnage, up a little over 36% from a year ago. Take a look at the charts to see the entertaining and dramatic swings.

Legitimacy

Eurasia Group president Ian Bremmer notes the differences in the Chinese market, “Local investors see the stock market as a short-term place for profit-taking, not an indication of China’s well being, and are far more confident in the Chinese authoritarian, state-capitalist system (and are certainly untroubled by its sustainability as a new, hybrid model).” Essentially, firms rely much less upon the stock market as a means of capitalization. While something like the NYSE is closely correlated with the health of firms, the Shanghai is viewed as more of a casino. Hugh Young, an investor in Asian securities for Aberdeen Asset Management, claims that throughout the years the Shanghai composite has been “highly speculative — a casino,” and that the swings are an easy way for the media to procure headlines. Back in May, the Economist suggested that very concept as it examined the growing, unexplainable discrepancy between Hong Kong’s markets and the mainland’s, even as economic growth in China was slowing.

Conclusions

In my (and many others’) opinion, investors should not fall for breaking news headlines. Chinese economic data, while slowing, is nowhere near as apocalyptic as their stocks suggest. In reality, a currency devaluation, like the one that happened earlier in August, is much more reflective of the health of The People’s economy than casino-like swings in the Shanghai composite. As China begins its transition to a consumption-based economy, hiccups are bound to occur. Those do not indicate the future of the entire country, however. Once the swings begin to subside, U.S. domestic investors will hopefully pay attention to domestic indicators, which currently look quite strong. China is not in any danger of losing its position globally, but it will be interesting to watch as several fundamentals (demographics, debt, consumption, etc.) significantly change.

We welcome constructive criticism at The Atlas Business Journal. Leave a comment below, but if its remarkably scathing, Shaan prefers to read it over email. Contact him at shaan@atlasbusinessjournal.org. Thanks!