One year ago, investors were struggling to make sense of a global stock market slump. Equity prices in London, New York, Hong Kong, Shanghai, Frankfurt and Paris all fell on August 24, 2015 – thanks to China devaluing its currency in the preceding weeks. The Shanghai Composite lost 10% of its value on August 24, while the FTSE 100 and the Dow Jones both fell 5%, and the Nasdaq lost 10%.
This was not the first time the Shanghai Composite had lost value that summer. Between June 12 and July 3 the index fell from 5,166 to 3,687 – prompting the Chinese government to step in and prop up the market. The range of weapons it deployed was staggering, ranging from liquidity injections to editorial cheerleading to threats of criminal prosecution.
While the Chinese stock market year-to-date has displayed considerably less volatility than 2015, investing is not without risks. If the U.S. dollar strengthens, it will be detrimental to emerging markets – and if the Fed raises rates as expected before the end of the year, the dollar will rise too.
Commodity prices are also a concern; they may have strengthened over the course of the year but should the cost of oil fall back this could be detrimental to emerging markets.
“According to the vast majority of investment commentators, hedge fund managers and much of the media, China was supposed to have collapsed by now,” Tom Becket, chief investment officer of Psigma told Emma Wall, senior editor for Morningstar.co.uk. “However, the ongoing economic rebalancing will continue to create nerves for investors at regular intervals. After a period of uncharacteristic tranquillity, it is entirely possible that another speed bump could be hit in the coming months over capital outflows, FX depreciation or patchy economic data, but our central case remains that one should be balanced on China and eschew the overly bullish and aggressively bearish views that many hold.”
What next for Chinese growth, currency and equities?
Francisco Torralba, senior economist for Morningstar Investment Management, shares his views.
The July 14 batch of official data suggests the economy is growing at a stable pace around 6.7% a year. Alternative estimates put China’s growth one to three percentage points lower than the official figure, but at least confirm that growth has remained stable.
Relative to the first quarter, in the three months to the end of June industry picked up some momentum, whereas construction and service industries eased slightly. Within services, however, finance was the only sub-sector with declining output in Q2, relative to a year ago. The decline in stock market turnover, after the 2015 market crash, has probably reduced trading. Transport, retail, hospitality and real estate services all saw improved momentum.
Since worries about the growth outlook have waned, government bond issuance and public spending are likely to slow down. When they do, headline growth will fall, and market volatility will return.
At present Chinese markets are relatively calm. The renminbi weakened 1% against the dollar after the Brexit vote, but on trade-weighted terms the currency has been stable. The offshore spread of the renminbi is narrow, consistent with small capital outflows and no expectation of immediate depreciation.
The People’s Bank of China is likely to intervene in the event of pressures against the currency, but the recent history is not reassuring. Despite the central bank’s commitment in December 2015 to keep the renminbi “relatively stable,” its value has declined 2.8% since then. Investors, however, appear today more comfortable with a depreciating renminbi than a few months ago.
In late 2015 and early 2016, a falling exchange rate was cause for much concern, whereas the yuan’s weakness since March – a 3.3% decline – has not been associated with market turmoil. If that decoupling persists, the People’s Bank of China might be more willing to allow the renminbi to depreciate.
That would be welcome news, since a weaker currency would lift Chinese inflation and might replace credit growth as the main policy tool to support growth. The stock market was less shaken than elsewhere by the late-June volatility. Besides Brexit, China’s equities ignored the June 14 decision by MSCI to deny Chinese A-shares entry into its market indexes. Speculative trading is much less prevalent than during the 2015 bubble, and appears less vulnerable to switches in sentiment.