Asset Allocator: July 2015- Is China a Crisis?

In this week’s Asset Allocator, David Stevenson looks at the recent fate of China where, despite the eyes of Europe being focused on Greece, stock markets indices have fallen as much as 30% in the past weeks. David weighs up the two most prevailing thoughts surrounding China about whether we have entered a crisis phase or events are not as bad as some believe.

 The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only.

 Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment.

 This article has been published for marketing purposes and has not been prepared in accordance with those legal and regulatory requirements which are designed to promote the independence of investment research. There has been no prohibition on dealing ahead.  It was not subject to any prohibition on dealing ahead  prior to its publication on this website.

 


ASSET ALLOCATOR: JULY 2015

 

13/07/15- Is China a Crisis?

 

Whilst we in Europe have been obsessing over everything Greek related the rest of the world has been paying much closer attention to events in China. Local equities have, to put it mildly, gone into reverse after a staggering bull market run which at its peak saw the local growth market - the Chinext - valued at a rather fruity 147 times earnings.

Over the last few weeks virtually every major news outlet has been full of stories about private Chinese investors in varying stages  of open panic. Margin trading – one of the prime drivers of trading – has collapsed, and the Chinese government sensing public panic has rushed to the policy barricades. The IPO pipeline has shut down, banks are withdrawing loans, and trading on some days has actually seized up. The Economist magazine reports by the end of July 7th trading in over 90% of the 2,774 shares listed on Chinese exchanges had been suspended or halted. The magazine also noted that on some days, only 11% of stocks were actually trading, although that number had improved to 40% within a few days. The big numbers in terms of impact are also fairly stark. Apparently some $3.5 trillion in wealth has been destroyed, although it is worth observing that stock market wealth is not a major player within the Chinese economy – local markets represent a third of GDP, compared to 100% in developed economies.

Given that the roaring success of the local stock markets has been a source of huge pride amongst policy makers within the Chinese state, none of us can be surprised that the government has swung into action. The Economist reports that the latest “government ploy to stabilise the markets has been to suspend trading in weaker stocks and to force state companies to step in as the buyers from private sellers. They are also preventing any listed shareholders with over a 5% stake (including executives, board members etc.) from selling for 6 months.”

Yet even after the dramatic falls of the last few weeks, it’s worth observing that Chinese equities still trade at many times the levels seen this time last year. Take the broad MSCI China index, which has been slightly less turbulent than its more mid to small cap index peers. Back on the 11th June 2014 this index traded at 2858, but had hit a peak of 7226 by 11th June – it’s now down at 4751, which is roughly where the index was in early March of this year. So, in simple terms, equity markets are probably only back to where they were this spring!

What will happen next? Analysts at research firm Check Risk have what I think is very interesting take on Chinese shares using momentum and sentiment based measures. The complex looking chart below shows two lines – a dark one belonging to the MSCI China index, the blue line representing their own compound indicator for short term sentiment. You can see that as the MSCI China index has plunged, sentiment levels have also collapsed. This measure now suggests that local equity sentiment is at medium term lows. 

 

 According to Check Risk “short-term sentiment has now reached extreme pessimism whereby the level of confidence in positive forward returns has increased dramatically – being a contrary indicator….Putting together the picture from the sentiment and momentum indicators it would suggest a short-term inflection point is imminent. The medium-term (6 month) indicators still suggest being light on risk, but shorter-term investors may be rewarded if they start nibbling.”

Another canny observer of Chinese issues is Beijing based investor Chris Rynning, head of London listed firm Origo Partners. He boasts a loyal on line following for his regular blogs and has been consistently positive about the long term growth prospects for Chinese equities although in recent months he turned much more cautious. His view is that “the Chinese stock market will continue to fall another 20-30% before stabilizing. The main reasons for stabilisation include: 1. The PBOC will continue to support with liquidity2. Margin loan balance has come down to US$260bn, or equal to April 8 levels. When we are at February levels, I think most margin risk is taken out and markets will stabilize. I suspect in the meantime there will be further redemptions and panic selling driving markets lower. However, this is not a systemic economic collapse in China. It is a stock market correction of levels that went too far, too quickly.”

My own sense is that the truth lies somewhere between Rynning and the analysts at Check Risk i.e we might be approaching a key turning point in the next few weeks or months. We are probably due another bout of selling and I wouldn’t be surprised to see another 10 or 20% come off the big Chinese indices, including the CSI 300 index used by Lyxor for its ETF tracker. The cue for this might be the realisation that despite massive government intervention, leveraged meltdowns usually tend to take at least a few months to work through properly. Chinese equities had been lowly valued back this time last year and as I have said many times in these weekly articles the subsequent rally was justified simply based on valuations alone. But like all momentum driven trades, Chinese shares got ahead of themselves and they need a proper 30 to 40% correction – we’re currently only 20% into the move.

 It’s also worth observing that Chinese equities have ALWAYS been volatile, and hugely sentiment and government policy driven. As a long term investor in China this sudden bout of panic selling is absolutely no surprise – the tell-tale signal of potential distress was that massive level of margin debt being used by private investors.

 For global investors the more important  narrative is what experts at Check Risk call the ‘network’ risk issue i.e the potential for financial panic to hit other closely related markets. The chart below shows the Shanghai index (SHCOMP) alongside the AussieDollar (AUD), Copper (ETFS) and Oil equities (USO) – its immediately obvious that a wide range of commodity and equity markets are now hugely vulnerable to any more bearish twists down in the Chinese stockmarkets perhaps helped along by events in Greece. Again, my own guesstimate is that we’ll see continued selling pressure on oil, with a push down towards $50 a barrel a distinct possibility.

 

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The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes  responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.

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