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Bear in a China Shop
Mar. 1st, 2007 12:59 pmIt was interesting to read the various takes on the 9% fall in the Shanghai stock index on Tuesday. Analysts and newspaper columnists alike hate to have to shrug their shoulders and say that "these things happen; it was well overdue". And so they scramble around for a concrete "cause".
John Authers, whose analysis in the FT I usually admire, took the view that "in spite of the chronological sequence of events, the cause lies in the US, not in China". He forecast that the world's attitude to risk was changed significantly as a result of the fall. Safe havens, he implied, were back.
Now, I don't actually agree with this interpretation, but it's definitely an interesting line and I admire Authers for taking it. His view was that China, which exports masses of stuff to the US in return for pieces of paper that are gradually deteriorating in value (i.e., the US dollar) is a leveraged play on the US consumer. So, when traders saw that there were scary rises in the levels of default in the subprime lending in the US, they concluded that this meant a big fall-off in demand for Chinese "stuff", and therefore Chinese stocks were rapidly sold off.
A more common line of analysis was that the global sell-off was a reaction to the sell-off in China because China could no longer be considered an emerging market. If you reclassify China alongside Japan, Europe and the US, then an 8% sell-off would be expected to cause repercussions elsewhwere. And the falls in the UK and the US were more in line with this than with the "fundamental" cause being in the US.
But, why the sell-off in China? I don't really buy this "leveraged play" as an explanation. Sure, China is correlated with the US consumer's appetite for spending, but its stockmarket valuations were only partially correlated to the strength of US demand. Proof of this can be seen in the relative performance of the Chinese markets in 2005 (when it fell) and 2006 (when it rose 130%). US demand was strong in both years.
No, China was, basically, overbought in a dotcom-style "China is hot" kind of way, mainly by domestic rather than international investors, and mutterings in state-controlled newspapers had indicated that the Chinese government thought that the stockmarket was overbought. If the pullback follows the path travelled by the Nasdaq from late 200 onwards, we can expect further falls and a lethargic Shanghai index for 30 to 36 months.
The question that raises is, would that push the rest of the world into a recession? That is no longer as stupid a question as it sounds. But my immediate reaction would still be, no, it wouldn't. Not least because the Chinese government has consistently shown a shrewder understanding of the vagaries of the markets and of capitalism than have the governments in mainland Europe, the UK and the US. The Chinese government would quite like to see a "flat" year, and it has several means by which to achieve this.
Now, here we come to the interesting question of "who has more power, the traders or the government?" When currency traders took against the pound in 1992, Norman Lamont walked along blithely assuming that the Bank of England was on a par with the Bank of Japan when it came to the ability to move markets. Of course, it wasn't; this was a bit like comparing Chelmsford Town to Manchester United (no disrespect to Chelmsford intended). If the markets really took against Chinese stocks, then the Chinese government might find it a bit harder to engineer the "soft landing" in its stocks than it anticipated.
But the reaction of the past couple of days seems to indicate that it's mainly been seen as a "tremor" rather than a full-blown quake. The world is a different place now than from 1987, although I am seeing worrying reminders of the fervour for junk bond buyouts in the current craze for private equity. There might be some bad times down the line, but I don't see it for this year.
John Authers, whose analysis in the FT I usually admire, took the view that "in spite of the chronological sequence of events, the cause lies in the US, not in China". He forecast that the world's attitude to risk was changed significantly as a result of the fall. Safe havens, he implied, were back.
Now, I don't actually agree with this interpretation, but it's definitely an interesting line and I admire Authers for taking it. His view was that China, which exports masses of stuff to the US in return for pieces of paper that are gradually deteriorating in value (i.e., the US dollar) is a leveraged play on the US consumer. So, when traders saw that there were scary rises in the levels of default in the subprime lending in the US, they concluded that this meant a big fall-off in demand for Chinese "stuff", and therefore Chinese stocks were rapidly sold off.
A more common line of analysis was that the global sell-off was a reaction to the sell-off in China because China could no longer be considered an emerging market. If you reclassify China alongside Japan, Europe and the US, then an 8% sell-off would be expected to cause repercussions elsewhwere. And the falls in the UK and the US were more in line with this than with the "fundamental" cause being in the US.
But, why the sell-off in China? I don't really buy this "leveraged play" as an explanation. Sure, China is correlated with the US consumer's appetite for spending, but its stockmarket valuations were only partially correlated to the strength of US demand. Proof of this can be seen in the relative performance of the Chinese markets in 2005 (when it fell) and 2006 (when it rose 130%). US demand was strong in both years.
No, China was, basically, overbought in a dotcom-style "China is hot" kind of way, mainly by domestic rather than international investors, and mutterings in state-controlled newspapers had indicated that the Chinese government thought that the stockmarket was overbought. If the pullback follows the path travelled by the Nasdaq from late 200 onwards, we can expect further falls and a lethargic Shanghai index for 30 to 36 months.
The question that raises is, would that push the rest of the world into a recession? That is no longer as stupid a question as it sounds. But my immediate reaction would still be, no, it wouldn't. Not least because the Chinese government has consistently shown a shrewder understanding of the vagaries of the markets and of capitalism than have the governments in mainland Europe, the UK and the US. The Chinese government would quite like to see a "flat" year, and it has several means by which to achieve this.
Now, here we come to the interesting question of "who has more power, the traders or the government?" When currency traders took against the pound in 1992, Norman Lamont walked along blithely assuming that the Bank of England was on a par with the Bank of Japan when it came to the ability to move markets. Of course, it wasn't; this was a bit like comparing Chelmsford Town to Manchester United (no disrespect to Chelmsford intended). If the markets really took against Chinese stocks, then the Chinese government might find it a bit harder to engineer the "soft landing" in its stocks than it anticipated.
But the reaction of the past couple of days seems to indicate that it's mainly been seen as a "tremor" rather than a full-blown quake. The world is a different place now than from 1987, although I am seeing worrying reminders of the fervour for junk bond buyouts in the current craze for private equity. There might be some bad times down the line, but I don't see it for this year.
