A renewed Chinese stock market rout rippled through international markets on the first trading day for 2016. Fresh concerns over the health of China's economy sent global equities down by the most in more than four months.
European indices fell between 2-3%, with the US stock market fearing slight better, down 1.5%. Chinese share market sank almost -7% triggering a trading halt in China and its largest one day fall in 9 years.
Shenzhen Composite Largest falls since 1996
Why?
A combination of factors can be highlighted as the major drivers for the market selloff. Below discusses these points in detail
Weak data
Chinese growth concerns were brought back into the limelight as weak Chinese manufacturing data once again spooked investors in regards to China’s economic strength. The Chinese December manufacturing survey was announced at 48.2 which was slightly below expectations (a number below 50 indicates manufacturing activity is contracting).
Although it was not a material decline and the market is already aware the Chinese economy is slowing, it reiterated the growth concerns that surfaced in 2015.
China faces a challenging time ahead as it attempts to transition the focus of its economic growth from investment and manufacturing to consumption and services. In the past manufacturing has been the major driver of economic growth, however these industries are nearing the mature stage of their life cycle. As a result, a new driver of growth is needed and believes the void will be filled by its services and consumption sectors.
The middle class in China has under gone a major transformation, incomes have spiked and they are now seen as the powerhouse of future economic growth for the country. The wealthier middle class are expected to drive domestic consumption as they are able to access more goods and services.
The fact that China’s manufacturing industry is slowing, is having spill over effects on the global economy. Its reduced rate of growth, through its diminished imports and lower demand for commodities is flowing on to countries that in the past have been reliant upon these industries. As a result these sectors are also likely going to need to adjust. The mining and energy sectors in Australia are currently undertaking this transition.
There is however a major plus to the economic evolution. The development of the Chinese consumer is likely to lead to new industries prospering. Two major industries we believe will be major beneficiaries are tourism and agriculture. Both sectors have a high correlation to population wealth. With the income of the Chinese middle class continuing to rise, we expect to see these sectors outperform. Hence has a large tourism and agriculture exposure though a variety of channels (both directly and indirectly) in both its Australian and New Zealand portfolios.
New safe guards introduced
Yesterday China implemented a new system-wide circuit breaker on its equity market. A circuit breaker has the intention to stop the market trading, give it time to revaluate and if trading volumes are thin, allow more market participants to enter the market to attempt to stop the market selloff.
The circuit breaker took effect after a 5% decline in the Chinese share market index, which creates a 15-minute trading halt. After a 7% drop the market is closed for the rest of the day. After hitting the limit of 5% and reopening after 15 minutes, it took roughly 2 minutes to hit down 7%, which triggered the final halt and closed the market.
The new ‘safe guards’ appeared to have caused more volatility and uncertainty than expected. Investors rushed to sell once the initial 5% circuit breaker was triggered, as they attempted to exit the market before further price declines occurred. However, the rush of selling appears to have resulted in a much worse outcome than without circuit breakers in place.
Restricted selling lifted
A major driver of yesterday’s selloff also relates to the unwinding of emergency measures that the Chinese government had put in place last year. Mainly, investors fear the proposed lifting of insider selling and allowing restricted stock holders to sell on previously halted stocks. Investors are concerned that this will result in large price declines and instead have attempted to sell ahead of these moves. The lifting of the trading ban is scheduled to be removed this Friday.
What now
The China’s stock market is actually a poor bellwether for the Chinese economy. There is a heavy retail investor composition who account for more than 80% of on market transactions. As a result speculation on stocks has become common rather than focusing on investing and wealth creation. In thin and illiquid market conditions share price moves can be over extended.
We believe 2016 will see a stabilisation of growth for China, following the massive stimulus measures implemented by the Chinese government last year. Our view is that the Chinese economy is certainly not on the brink of collapse, and an expected growth rate of around 6.5% – 7.0% for next year will be supported by further stimulus from the Chinese authorities if required.
Further, we believe China’s economy is in a multi-year transition highlighted by an improvement in data around the services sector, which is outperforming and actually generates more jobs than manufacturing.