We have said for a long time that we are not overly concerned about any hard landing in China – the government of the world's second largest economy has far too much in financial reserves so we think it likely that it can weather any economic slowdown. But that doesn't mean we shouldn't keep an eye on China in case circumstances change dramatically, because the country's performance has a significant effect on the rest of the world.
The recent collapse in the Chinese stock market is therefore interesting in what it tells about how the People's Republic may react. At first glance the falls in share prices aren't really marked. When the government first intervened a couple of weeks ago to try and slow the pace of decline, markets had only dropped to levels seen in March. Even now, share prices have only slid to levels of last November - not much more than half a year of growth lost. So why is the government getting so antsy?
Our core thesis is that it's all to do with sentiment. Much in the same way that a UK Chancellor will always want rising house prices in order to keep UK consumers sweet and spending, the Chinese government is acutely aware that its citizens are some of the keenest investors in domestic shares. With their investments sliding in value, the people are in no mood to spend money. Already anecdotal evidence is coming in of Chinese consumers keeping their hands and wallets stuck in their pockets.
This particularly matters as the Chinese government has tried to shift the economic balance in recent years away from infrastructure investment and towards a reliance on consumer spending as a way of boosting gross domestic product. That earlier scattergun infrastructure spend has interestingly contributed to some of the problems for China we see now – many of the loans taken out by companies to pay for the building of vast new cities have no hope of being paid back, and the government is being forced to underwrite many of these debts. The inability to pay back borrowings, and the subsequent effect on banks and corporations, is another source of lost confidence in the nation.
So if its attempts to quell the stock market unrest aren't really working, and its underpinning of losses related to infrastructure investment isn't improving confidence, what has the Chinese government left to do? This is where the rest of the world comes in.
The Chinese economic miracle was built on mass manufacturing and exporting to the West. If they can't now rely on their domestic consumer to keep economic momentum going, then they may revert to expansion through selling to the rest of the world. And if China starts to flood the global economy again with its wares, the effect worldwide could be significant: the pace of economic recovery elsewhere could be slowed as demand for western goods is damped; the speed at which employment levels are growing, particularly in the US, could be hit; and the price growth that central banks (terrified of Japanese-style deflation) across the world have been seeking could be slowed due to an influx of Chinese-made goods. The bottom line is that we may have to wait even longer for those interest rate increases that we have been talking about for some time (Mark Carney saying recently that UK rates might rise at the end of the year is neither here nor there in the context of a global economy).
Reverting back to the recent interventions – as we have said, our understanding at present as to why the government is putting so much effort into halting the stock declines is due to the effect on consumers. But as is often the case in China things are not always clear – it's unlikely, but we should not discount totally the chance that the extreme action – almost overkill – by the government might be it trying to mask a more fundamental underlying problem.
Does any of this matter to Turcan Connell Asset Management investors? The stock declines aren't really an issue, as we have limited exposure to the Chinese market. But any change in the timing of interest rate increases will of course affect how investments perform worldwide. And any indication that things in China are significantly worse than previously thought could obviously affect global sentiment. We will, as ever, be watching events closely in coming weeks.
This content was generated prior to Turcan Connell Asset Management Limited operating as Tcam.