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STONE MOUNTAIN CAPITAL RESEARCH PERSPECTIVE VOL. 3
One of the major current talking points among investors and economists has been the sharp declines in the price of Chinese stocks since mid June 2015. Should these declines be regarded as a healthy correction or is there something more serious going on and has the bubble burst? What is the impact of stock market gyrations on the broader Chinese economy and will the effects spill over to global stocks, particularly of companies with significant China exposure?
Chinese stocks had been “on a tear” during the second half of 2014 and the first half of 2015. The Shanghai Stock Index jumped by 53.3% in 2014 (with most of the gains coming in the last 5 months of the year) and by a whopping 152% in 12 months to June 12th 2015, when the index reached a closing 7 year high of 5,166. A correction after such spectacular growth was over overdue and should not have come as surprise. In early August, even after a 30% correction, the index was up by close to 70% compared to a year earlier. Even for calendar year 2015 year to date, the index is up by 15.8%. So, we are hardly looking at a disaster scenario, especially for long-term investors.
Some of the factors that explain the strong surge in the Shanghai Index in the second half of 2014 and first half of 2015 include:
· Excess liquidity and rapid expansion in margin trading (by July 2015 margin trading had risen by nearly four fold compared to a year earlier).
· Rising interest from FII after foreign investors were allowed to invest in the Shanghai market via brokers in Hong Kong. The possibility that domestic A-shares could soon be included in the MSCI Emerging Markets Index, acted as a further encouragement for global institutions to step up investments.
· Cooling-off in the property market and diversion of funds from real estate to stocks. Capital control means that most Chinese investors cannot invest in overseas equity markets.
· Momentum plays a major role on an exchange such as Shanghai and once share prices started their spectacular run, more and more retail investors (and global funds) were enticed into the market, culminating in the peak on June 12th.
· Economic fundamentals had already started to deteriorate when stock market has commenced is ascent and cannot explain either the ascent in the index or its subsequent decent.
The market had clearly become frothy and was long overdue for a correction. In early June, the decision by MSCI to defer its decision (by another year) to include A-shares in the emerging market index can be regarded as one of the catalyst that triggered a sell-off by global funds. This was accompanied by profit taking by global as well as domestic investors. Then, momentum took over and prices quickly started to spiral downwards as panic set in.
Just like the spectacular gains could not be justified by economic or company fundamentals, it is hard to put the blame for the sharp declines since June 12th on deteriorating economic or corporate fundamentals.
Government authorities had been passive when the market was surging but the sell-off prompted a string of official interventions, including a ban on short selling, halt in initial public offerings, a ban on sales by big shareholders as well as liquidity injections and direct government share purchases. These and other moves calmed the market initially but have reinforced the view that the Shanghai Exchange cannot be regarded as properly functioning market. The moves have also raised questions about China’s financial stability and its commitment to liberalizing markets.
Economic slowdown in China was already being factored into global stocks having significant exposure to China. The recent gyrations in the Shanghai Stock Exchange have not changed these dynamics. Global stocks with China exposure will continue to be more responsive to macroeconomic and sector specific news from China than the performance of the Shanghai Exchange.
For investors, China has certainly been an exciting roller coaster over the last year. Even after recent corrections, many will be sitting on spectacular gains but those who entered the market on June 12th will be sitting on a 30% loss.
Time to enter the market? Only for the brave and then with a small fraction of your portfolio with emphasis on stock picking rather than passive index investing!
Ashvin Chotai has been covering developments in China for over 15 years. He is Managing Director at Intelligence Automotive Asia and was previously the Head of Asian Auto Research at Global Insight, now known as “IHS Automotive”.
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The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, Stone Mountain Capital LTD. Readers should refer to the Disclaimer.