The 2016 global stock market meltdown is easily attributable to China. After all, China not only led the way timewise but also in terms of magnitude. Ostensibly, the China debacle was triggered by the widening spread between the onshore and offshore yuan and the ultimate move by the PBOC in changing the peg of the yuan to the dollar. In many respects, the further devaluation of the yuan has been anticipated since last August. Stock market sentiment has been further pressured by the anticipated lifting of the ban on trading by large shareholders. It was scheduled to expire towards the end of this week. Sentiment was not helped by newly formulated circuit breakers.
We knew from our experiences in US markets that as much as circuit breakers are meant to calm the markets, more often than not they tend to exacerbate the problem at least on the short term. In the China market where 80% of investors are retail and where we euphemistically call it the “Wild Wild East”, the reaction was anything if not extreme. It is natural to assume that especially given the circumstances, the initiation of the use of the circuit breaker would bring on additional selling pressure and that it did this morning when the Shanghai market declined 7% in the first 29 minutes of trading.
This of course creates an opportunity for everyone, those who know about China and its financial markets and many who know very little, to sound off. This includes those who have superficially studied it but have never been to China, and everyone who is a self-styled master of the universe.
As we enter a new year, the annual ritual of, “Will there be a hard landing in China this year?” again rears its ugly head. We are amused by a self-styled expert appearing on TV the other day reciting the time tested statement that every government statistic by China is fraudulent and that the real economy in China is growing at about 1%. Unlike North Korea, China is not a state that is ruled by fear so it makes one wonder how a one-party regime can stay in power. After all of the bad news about China that has been globally telegraphed, the latest piece of the doomsday jigsaw puzzle is the issue of declining foreign reserves. Foreign currency reserves dropped to $3.3 trillion by the end of 2015. The naysayers have seized upon this as another sign of the beginning of the end of China’s growth story. I think we all understand that foreign currency reserves is not a never ending expanding number for China. Much of the last trillion literally were added in the last 5 years. After the July/August 2015 market debacle, it would be natural to assume a decline in the reserves, but at year end it still stands at $3.3 trillion.
When it comes to China, there is no question that there are key fundamental issues at hand. In addition, the Chinese authorities have made serious misjudgments about the fundamental nature of financial markets. However, the speedy abandonment of the recently instituted circuit breakers makes us hopeful that they are quick learners. We have maintained that instead of worrying about the short term behavior of the marketplace, the Chinese government should focus on the principal issue at hand, which is the direction and health of the Chinese economy and not be distracted by side shows such as the behavior of stocks at least over the short term. Not only are they distractions but in their focus on market behavior it makes some of us believe that they are taking their eyes off the ball. In fixing the health and well-being of the Chinese economy, all of these other issues become very secondary.