Optimism in Chinese economy a silver lining after selloff

Share

The sudden collapse of Chinese stocks is rippling through global markets, but outright panic is contained within China's borders – at least for now.

The barriers separating the Chinese market from the rest of the world are serving as shock absorbers, dulling the impact of the crash on portfolios here.

"How quickly everything is moving is a little unnerving," said Christine Tan, a senior portfolio manager in charge of an emerging markets fund at Excel Funds Management Inc. "But the underlying economy is okay. We just went way too far, too fast. If I start seeing it flow through to the real economy in China, I change my base case."gr

China is quickly overtaking Greece as the prevailing concern among investors, as the dizzying selloff in Chinese stocks weighed on Asian, U.S. and Canadian markets in Wednesday's trading. But there is some optimism that the fallout can be largely limited to mainland China.

Stocks there had run up so quickly that it didn't require a contrarian to predict a contraction. The Shanghai composite index had risen more than 150 per cent since last July, with Chinese investors taking advantage of plentiful margin loans to quickly build up portfolios. The amount of margin finance extended to investors doubled in the first half of the year to 2.1 trillion yuan, or $339-billion (U.S.), according to Bloomberg.

Stock valuations soared, opening up a 30-per-cent premium against Hong Kong-based equities as measured by stocks listed on both exchanges, Ms. Tan said. "The rally was phenomenal. Valuations were very stretched."

Those debt-fuelled trades have begun to quickly unwind in recent weeks, as selling pressure has mounted. That frenzy has taken hold of China's retail investors, who account for about 85 per cent of the trading on the Shanghai and Shenzhen exchanges, Ms. Tan said.

The Shanghai index has declined more than 30 per cent in less than four weeks – falling 6 per cent on Wednesday alone – fuelling concern of a destabilizing shock that could spread well beyond China.

The Chinese government has attempted to restore confidence by imposing controls on trading. Most recently, major shareholders, directors and executives were banned from selling stakes in listed companies for the next six months. IPOs have been suspended. And about half of all listed companies have opted to voluntarily suspend trading of their shares.

Those measures have so far failed to subdue a selloff that has wiped out about $3.5-trillion so far.

"People are getting pretty nervous now," said Ross Yarrow, director of U.S. equities at Robert W. Baird & Co. in London. "My clients are starting to get more concerned about China than they were about Greece. Just think of the sheer size of China's stock market – it's losing multiple times the value of Greece's GDP almost every day. China has the potential to have a material effect on global fundamentals."

With much of the Chinese market effectively shut down, investors are seeking liquidity by selling higher-quality issues, Ms. Tan said. "That's why you're seeing the pullback widen out beyond smaller, expensive, high-growth stocks to large insurance companies and banks."

The Industrial and Commercial Bank of China's Hong Kong-listed shares have dropped 18 per cent in the past two weeks, for example. Ping An Insurance, one of Asia's largest insurers, which trades as an American depository receipt in New York, has declined 25 per cent over the same period. Ms. Tan blames liquidity seeking – individual investors shedding risk and raising cash and portfolio managers needing to sell to fulfill redemption requests.

Risk aversion fuelled by Chinese volatility also drew down the S&P/TSX composite index 1.5 per cent and the S&P 500 1.7 per cent Wednesday.

And yet the channels of direct contagion out of China are fairly narrow. Chinese officials have recently opened up their markets to foreign investors, but only on a strict, limited quota.

Mainland China has close financial ties with Hong Kong, but the latter's trading is dominated by institutional investors, which tends to add stability, Ms. Tan said.

And the rest of the world is more concerned with China's economy than its stock market. The economy is slowing, but it is not yet showing signs of vulnerability to the stock rout.

"There is a limited impact on the average consumer," said Stephen Lingard, senior vice-president and portfolio manager at Franklin Templeton Solutions. "This may slow business investment somewhat given uncertainty, but it shouldn't have a significant impact on economic growth going forward. … We continue to have long-term conviction in the China story."

With files from Bloomberg