The great fall of China?

6 Oct 2015

The repercussions of China’s woes across global markets will have had nervy investors questioning their asset allocation, but is now the time to panic? Sebastian Cheek finds out.

“For the five-year-plus horizon, China is the place to go, but I will not recommend any immediate short-term investments.”

Aniket Bhaduri

China’s ‘Black Monday’ hit like a whirlwind on 24 August after a dramatic 8.5% drop in the Shanghai Composite index, the biggest one-day sell-off since 2007. Shockwaves spread the world over and a sea of red descended on traders’ screens. The Dow Jones shed 1,000 points in early trading, finally closing 588 points down, while the FTSE 100 dropped £74bn closing at 5,996, compared to its lofty 7,000-plus highs earlier in the year.

The FTSE recovered by 3% the following day jumping to 6,081 by the close of trading, while the Dow Jones gained 619 on 26 August, buoyed by the Chinese authorities’ decision to cut interest rate and reserve ratio requirements. However, while the crash and subsequent dead cat bounce was indicative of the short-term volatility investors are used to, it was also a clear sign of China’s slowing economy and the result of a number of measures implemented by policymakers in recent months to address this.

China’s previous notable stock market dive in July led the government to introduce a number of hard-hitting measures including cutting interest rates, increasing liquidity provision, loosening margin requirements, supporting a market stabilisation fund and instructing direct government investment. The government also halted IPOs and banned major shareholders from selling shares.

Then on 11 August the People’s Bank of China (PBoC) undertook an aggressive devaluing of the yuan (renminbi), changing how it sets the daily fix for the yuan against the US dollar. The fix is now based on dealers’ foreign exchange (FX) quotes for the market close rather than a black-box value determined behind closed doors. The yuan subsequently fell 1.9% against the dollar, its biggest one-day adjustment since 2005. The move initially triggered a risk-off sentiment in Asia and, more broadly, in global equity markets, while in the FX markets, regional currencies showed sympathy with the yuan, particularly in Indonesia, Thailand and Malaysia. Meanwhile, commodity prices fell across the globe.

Where does this volatility in equity markets and currency drop leave institutional asset owners exposed to the region? Those who enjoyed the recent rally in Chinese stocks have faced the question of whether to sell or stay put, while those not invested could take the opportunity to pick winners. While many might feel it’s time to panic, the overarching message seems to be: hold your nerve.

BURSTING THE BUBBLE

Prior to the crash, the Chinese stock market had been yo-yoing for some time following a sustained period of stellar growth which saw the A-share market treble in just 18 months. According to Bloomberg, Chinese retail investors opened more than 50 million securities accounts in H1 2015 and pushed the Shenzhen Composite Index performance to a staggering +121% in June, before sinking back to +23.5% year-to-date.

JLT senior investment consultant Aniket Bhaduri believes the bull market catalyst came in 2009 when policymakers instigated a huge credit push which stimulated double-digit growth for the next five years. The bubble was exacerbated by other factors including the rapid expansion of shadow banking, an increase in margin lending and, more recently, the opening of the Hong Kong-Shanghai Connect last autumn which enables investors in each market to trade shares on the other market.

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