Canary in the coal mine or elephant in the room? For investors, either idiom could apply to Chinese stocks in what is already shaping up to be a rocky ride for global markets this year.
Pessimists would go for the canary metaphor: the New Year dive that began in Shanghai serves as an early warning of how local events can have repercussions across the world.
Optimists would see China as the elephant: impossible to ignore but whose market is so tightly-controlled and largely shut off to foreigners that it shouldn’t have such a major bearing on the global investment picture.
If market moves this week are any guide, the swings in Shanghai stocks will exert a major sway over world markets this year even though China’s equity weighting is relatively small in global terms.
The fall in world stocks on Monday, the first trading session of 2016, marked the steepest opening day losses in years for many indexes.
Topping the list of investors’ reasons to sell was the 7 percent plunge in Shanghai shares earlier that day; this prompted China’s first nationwide suspension of trading plus a rapid reaction by the central bank and stock regulator, hoping to restore calm.
Worries about how robust China’s financial markets are, the ability of authorities in Beijing to support them and the overall health of the economy are nothing new. They triggered a global market slump late last summer. However, the extent of Monday’s fall and the global fallout caught investors off guard.
“Markets tend to drop every time Beijing intervenes. Investors sense desperation,” said Jack Ablin, chief investment officer at BMO Private Bank in Chicago.
Chinese stocks plunged 45 percent in the three months to August last year. That month the yuan currency underwent a mini devaluation and on Aug. 24 alone the Shanghai equity market tumbled 8.5 percent.
This particular fall caused tremors around the world. Wall Street chalked up its biggest loss in four years, with the Dow Jones down as much as 1,000 points at one stage that day.
In the past year Shanghai’s benchmark composite index has fallen 5 percent or more in a day on 12 occasions. The impact on Wall Street has been broadly negative, with the S&P 500 falling on nine of those days, including a 3.9 percent slide on Aug. 24.
But the correlation hasn’t been uniform. Four of the S&P’s declines were of less than 0.5 percent, and on three days the index was unchanged or higher.
For months, investors blamed Chinese markets and China-related factors for any imperfection in the world economy and markets. These concerns gradually receded as the U.S. Federal Reserve prepared for the historic interest rate increase that it finally delivered last month, and as a renewed fall in energy prices intensified the pressure on the European Central Bank to loosen its monetary policy further.
But with the Fed and ECB unlikely to act again for perhaps several months, attention has switched back to China.
“We’ve come full circle back to China. The level of volatility is concerning although it’s encouraging that the U.S. markets finished off their lows on Monday,” said Andrew Wilson, managing director at Goldman Sachs Asset Management in London.
CARRY THAT WEIGHT
Only seven out of 31 strategists in a recent Reuters poll cited China among their top concerns for U.S. stocks in 2016, though five others cited a global recession or slowdown as one of their biggest worries.
Part of the problem for investors will be separating what China’s economy does from what its stock markets do. There may be some connection between the two over time, but this has been less so in the last couple of years.
The Shanghai Composite rose 150 percent in the year to June 2015, during which time economic growth slowed to 7 percent from 7.4 percent – sizeable slippage by China’s stellar standards. Despite the tumbles, stocks ended last year up 10 percent, but the economic deceleration shows no sign of easing.
“The economic weight of China is much, much bigger than its financial weight,” said Luca Paolini, chief strategist at Pictet Asset Management in London.
“I wouldn’t put Chinese financial market volatility as the main risk for this year but if there’s contagion from the Chinese economy to the U.S. and European economies, that’s a much more dangerous development,” he said.
Chinese stocks have a weighting of just 2.5 percent in the MSCI All Country world index, while the U.S. weighting dwarfs all others with around 53 percent.
Economically, the two countries are on a more equal footing. Nominally, the United States accounts for around 25 percent of global GDP and China around 15 percent. But on a purchasing power parity basis, China is the biggest economy in the world with a 17 percent share, edging ahead of America’s 16 percent.
China’s deceleration means global growth is likely to slow too. Any significant undershooting of Beijing’s 6.5 percent growth target would put pressure on the U.S. and emerging market economies, as well as commodities and the exchange rates of the Chinese and other emerging market currencies.
Last year investors pulled an estimated $540 billion out of emerging markets, the first capital outflow from these economies since 1988, according to the Washington-based banking lobby group the Institute of International Finance.
Most of that was from China. Some private sector estimates put the outflow closer to $1 trillion, and the People’s Bank of China sold around $500 billion to counter these flows and prevent the yuan from plunging in value.
Bruno Taillardat, equity investment director at Unigestion in Geneva, said investors should be highly sensitive to capital flows out of China and further downward pressure on the yuan. He noted the Fed is gradually withdrawing the stimulus it poured into the U.S. economy to counter the financial crisis.
“Investors ignored risks in the past because they had to invest all the cash from central banks. But now this is a wake-up call,” he said.[Source:- REAUTERS]