The recent turmoil in Chinese stock markets has raised concerns about the resilience of not only the Chinese financial system, but the Chinese economy as a whole. At the beginning of the year Chinese authorities set themselves a GDP target of 7%, which on the face of it seemed quite conservative. While the most recent GDP numbers would appear to suggest that the economy is on course to meet that target, there is widespread suspicion that the economy is tracking well below that number. Since November last year the Chinese authorities have overseen four cuts to bank reserve requirements, as well as benchmark lending rates which currently sit at record lows. Yet throughout the course of 2015 successive indicators of the economy have shown evidence of a sharp fall in not only exports, but imports as well, with domestic demand staying weak. Through the first part of this year Chinese equity markets had been on a tear as the PBOC introduced measures to stimulate demand with the Shanghai Composite at one point up from levels of 2,200 in August last year, more than doubling in value and peaking at 5,178 on the 12th June. Since then share prices have dropped back sharply, falling back as far as 3,500 and the 200 day MA, which it has managed to find some level of support at throughout this month. Fears about the health of the Chinese economy have grown mainly as a result of not only the deterioration on the economic data, but also a sharp fall back in the demand for commodities in general over the past twelve months. We’ve seen widespread declines in not only iron ore, copper and crude oil prices, but also sugar, corn and wheat prices in the last few months, raising concerns of a pronounced slowdown in the world’s second biggest economy. These recent sharp declines are one of the most high profile manifestations of these concerns, along with uncertainty about Chinese authorities’ ability to deal with the many balls they are trying to keep in the air at the same time. For a large part of the year the stratospheric rise in Chinese equities had raised concerns about high levels of margin debt, which is borrowing money to purchase company stocks. For a Chinese government determined to promote a stock owning culture in a growing middle class, and a much more free enterprise economy, this sort of endeavour seemed like a “win, win” strategy Unfortunately life is rarely that simple as Chinese authorities are now starting to discover with their cack handed response to the recent slide in Chinese stocks. Their determination to support the stock market has undermined all their earlier rhetoric about wanting to open up investment opportunities in their local markets. Stock suspensions, short selling bans, forced purchases of shares by state owned investors and a ban on sales of shares by leading shareholders have all the hallmarks of a regulator panicking in the face of market forces it can’t even begin to comprehend or control. Having helped pump up the stock market earlier this year and encouraged small investors to pile in with borrowed money, the resultant crash and various restrictions on exiting positions by Chinese authorities will discourage further localised, as well as international participation in a market that is gradually turning into a train wreck in progress. The whole point of a stock market is that companies live or die by their ability to generate returns for shareholders, as well as looking to raise cash in order to invest and innovate. By enforcing the prohibition of share sales by listed companies large shareholders and directors, and suspending trading in certain shares, investors become trapped in loss making trades, shattering confidence in a market that owes more to the wild west and eroding confidence in a market that could well have seen inclusion in the MSCI as recently as last month. The decision not to include Chinese shares in the MSCI index now looks to have been an extremely wise decision and the current attempts by Chinese regulators to underpin the market are likely to have put back the day when Chinese companies ever get included in this global index. After all, what sensible investor is going to invest in a market which moves on a whim and where margin debt levels remain at significantly elevated levels, and the regulator jumps in with a big stick at the merest whiff of a disorderly market. The big question now is having embarked down this road is whether Chinese authorities continue down this interventionist track, or pull back and let monetary policy take the strain. This is likely to take the form of further bank reserve requirement and benchmark rate cuts, or Chinese officials could dig themselves an even bigger hole, by continuing the recently implemented restrictive practices that are currently prompting a small rebound. Whatever we see happen next Chinese equity markets are in for a rollercoaster ride, and further weakness in commodity prices could well see markets falling under their own weight, as small investors find themselves sitting on huge losses, on the back of borrowed money. The Hong Kong China H-Shares index has shown similar weakness, and while its move higher has been more nuanced, it was still up nearly 50% at one stage this year; it has pretty much given up all the gains seen since the November 2014 lows. A move through the July lows could well see further weakness just below 11,000 could well trigger further falls. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
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