It is 1979 and an American Thriller is released with Jane Fonda saving the US from a nuclear meltdown that would see reactor components burn 'all the way to China.' Scientifically speaking this is fanciful stuff, but what of the very real Chinese stock market accident happening right now in 2015. Could a stock market meltdown 5,000 miles away affect businesses and entrepreneurs here in the UK?
Before we deal with that question, let’s set the scene. In China, trading is dominated by individual investors (estimates have been as high as 80:20, individual to institutional). These fearless souls have plunged into the market, often leveraging up their investment and in the process the Chinese stock market had grown to become the second largest in the world, with a combined market capitalisation of some US$10trn.
Policy chain reactions
Driven by speculative money the market grew by 150 per cent in less than a year. Enough to give everyone on Earth US$1,000. Many companies rose day after day by the maximum 10 per cent, with many new IPO’s rising thousands of percent within months of listing. A rationale market this was not. PE ratios averaged 70:1, a hundred million people by some estimates were playing the markets, two thirds of whom had less than a high school education
What triggered it? Well, monetary policy helped with the Chinese central bank joining the Western world in reducing interest rates. Having just about tamed the massive property bubble, authorities were keen to avoid the slow down turning into a full crash and have been easing policy as a result. More than that the state cheered the stock market boom as it allowed some of the over-leveraged state entities to be refinanced using the private wealth of the populace.
The combination of monetary tools and state encouragement drove investor confidence and rising stock prices. As a nation, the Chinese have a reputation for enjoying a flutter…well, this was state sponsored speculation and they simply couldn’t get enough. Apocryphal stories abound of wily brokers encouraging 'ordinary folk' to leverage up their life savings many times over magnifying the risks.
An inevitable meltdown
It was unavoidable. Investors had bloated the prices of Chinese securities far beyond their fundamental value. Despite the Chinese Government’s best preventative attempts, Chinese markets suffered a 30 per cent 'correction' over June/July. Over half of the stocks listed on the main Chinese stock markets were suspended for fear of further drops. Massive state intervention 'ordered' brokers not to sell and leverage was made available in a state orchestrated campaign to hold the market up.
As the great reformer Deng Xiaoping once said, 'Zhong guo te se she hui zhu yi', loosely translated 'Socialism with Chinese characteristics'. Well, quite…not easy to see the Fed telling people they can’t sell what they own.
Results for the Chinese economy
We shouldn’t exaggerate the impact. The Chinese stock market will take time to recover but recover it probably will. The Chinese economy is a global powerhouse and has been an amazing feat of endeavour. Yes, capital levels at the brokerages will have taken a hit and the general public will be less trusting of the stock market and what they read in the papers (hopefully).
Fundamentally, the Chinese economy is not necessarily in trouble. The Caixin China PMI showed that China’s manufacturing contracted only slightly in its most recent reading. There has been considerable investment in Chinese infrastructure and the proposed creation of the Asian Infrastructure Investment Bank would suggest that with US$100bn in the kitty, future financing may not be a problem – this is China remember! That said the authorities have been deliberately seeking to boost consumer spending as a future driver of growth. Will the effect of a few trillion dollars of private wealth going up in smoke create a wobble?
A UK reaction?
So what does this mean for us over in the UK? There have already been some immediate ripple effects; the FTSE 100 saw five straight days of losses towards the end of July as a direct result of uncertainty around China.
Given recent volatility, Chinese investors are now more likely than ever to look to make their money work for them elsewhere. China has not been shy of acquiring UK and US assets over recent years, whether that is property, publicly traded equities, or US treasury bills at the national level. Chinese companies and investment firms have also entered the private equity market and are increasingly looking to the UK. Recently we have seen Hony Capital’s investment in Pizza Express, Wanda’s investment in Sunseeker International and Baring Asia investing in Cath Kidston.
What has happened without doubt is that a slowdown in the Chinese economy (which was underway before the crash, but may be exacerbated by it) has led to commodity pricing falling far and fast. Hundreds of billions of dollars have been wiped off the value of the oil giants, miners and others exposed to the commodity cycle.
But every cloud has a silver lining. Overall this is likely to result in reduced inflation pressures for UK PLC’s, potentially influencing the Bank of England when it comes to an interest rate turn. In the medium term, whilst there will be volatility, it is likely to keep the Western recovery on track as central bankers keep their foot to the floor, feeling they can safely ignore inflation concerns…at least for now.
We think the boom continues (yes, in the new world, this is a boom) and the hunt for return will drive activity. The music plays on… until it doesn’t. The Chinese meltdown is certainly burning its way towards the UK, but it seems it doesn’t currently have to power to deliver much more than a singe. Perhaps we should hope they don’t create another boom.