One year ago, investors were struggling to make sense of a global stock market slump. Equity prices in London, New York, Hong Kong, Shanghai, Frankfurt and Paris all fell on August 24, 2015 – thanks to China devaluing its currency in the preceding weeks.
“Any investors doubting the influence of China on global stock markets have had their reservations blown out of the water over the last week,” we reported on Morningstar.co.uk. “On top of China devaluing its currency, and the resulting fall in Chinese A and B shares listed in Shanghai and Hong Kong, Greece called a shock election last week. Markets do not like uncertainty, and so stocks began to fall.”
The Shanghai Composite lost 10% of its value on August 24, while the FTSE 100 and the Dow Jones both fell 5%, and the Nasdaq lost 10%.
In the US, Morningstar.com Editor Jeremy Glaser reported that investors were concerned about China’s impact on global growth, leading to them selling out of US equities.
“The drop in markets is starting to concern investors as they think about what is the wider impact,” Glaser reported. “What is the impact on the United States? How does it impact global currencies? How does it impact the global monetary market and commodities? What is happening with the wider emerging markets? I think as people revaluate their portfolios you are starting to see some of that shake out through the global stock market sell off.”
Government Intervention Exacerbates Problem
This was not the first time the Shanghai Composite had lost value that summer. Between June 12 and July 3 the index fell from 5,166 to 3,687 – prompting the Chinese government to step in and prop up the market. The range of weapons it deployed was staggering, ranging from liquidity injections to editorial cheerleading to threats of criminal prosecution.
“The scattershot approach suggested a hint of desperation,” said Daniel Rohr, senior equity analyst for Morningstar. “The government’s panicked and initially ineffectual response leads us to question the future of real reform in China's credit and currency markets, which are far larger and more important to the real economy than the stock market. Failure to implement key reforms heighten the risk of a debt crisis and diminish the economy's long-term growth trajectory.”
China: One Year On
Last summer’s volatility had far reaching effects – impacting not just global equities but central bank policy too. In year’s past, the US Federal Reserve made policy decisions based purely on US economic indicators. But with an increasingly integrated financial environment, China’s problems meant the Federal Open Market Committee decided against raising interest rates in its September 2015 meeting. This was a shock to markets, and investors, many of which had priced in the expectation of a rate rise.
By December, the backdrop was more sanguine, and the when the Fed did eventually raise rates that month, the committee stated the expectation for four quarter-point increases in interest rates in 2016. But the optimistic outlook did not last long. In January this year the Shanghai Composite fell from 3,539 to 2,655 and eight months later there have been no further US rate rises, thanks in part to continued Chinese stock market volatility.
Nick Peters, portfolio manager at Fidelity Multi Asset says that concern over Chinese equities have driven the huge inflows into gold funds – seeking out a safe haven asset.
“Many investors have looked to add to gold on the back of fears over global growth, with worries over a slowdown in China particularly prevalent at the beginning of the year. The impact of these fears can be seen on the gold price over 2016, with a sharp leg up occurring at the height of market panic in the second half of January,” he said.
Since the beginning of the year the Chinese market has slowly climbed to 3,090 – a relatively shock free rally.
What Does the Next Year Hold?
While the Chinese stock market year-to-date has displayed considerably less volatility than 2015, investing is not without risks. If the US dollar strengthens, it will be detrimental to emerging markets – and if the Fed raises rates as expected before the end of the year, the dollar will rise too.
Commodity prices are also a concern; they may have strengthened over the course of the year but should the cost of oil fall back this could be detrimental to emerging markets.
“According to the vast majority of investment commentators, hedge fund managers and much of the media, China was supposed to have collapsed by now,” said Tom Becket, chief investment officer of Psigma.
“However, the ongoing economic rebalancing will continue to create nerves for investors at regular intervals. After a period of uncharacteristic tranquillity, it is entirely possible that another speed bump could be hit in the coming months over capital outflows, FX depreciation or patchy economic data, but our central case remains that one should be balanced on China and eschew the overly bullish and aggressively bearish views that many hold.”
