The movement of stock markets has as much to do with human psychology as it does with the fundamentals underpinning the value of securities – that's a maxim we should bear in mind.
There are, of course, some very good reasons why markets have been falling, firstly, there is rightly a concern that China may be slowing far quicker than previously thought, and since this is the world's second largest economy, that could put a significant brake on the prospects for the rest of the globe. Add that to the turbulence that has been the crashing performance of Chinese markets over the past six weeks and you get a recipe for jittery investors the world over. The problem now is that those jitters may have taken too much control of the situation.
Stepping back from the noise and hubbub, it's worth noting that Chinese stocks have been out of touch with reality for some time – even after recent declines they are still up over 30% over the past year whilst the MSCI world index is down around 9% over the same period. As we have said before, the unnecessary and bungled attempts to intervene and support equities have only made the situation worse.
The trigger for the recent sell off has been China's devaluation of its currency. The resultant crisis in confidence looks to be an overreaction, given the renminbi peg to the US dollar had led to the Chinese currency becoming overvalued. About 19% of China's trade is with Europe and 16% is with Japan (a similar proportion to its trade with the US) so having the currency appreciate because of US dollar strength when their economy is slowing, and Japan and Europe are pursuing quantitative easing, renders them uncompetitive. A move to a more flexible exchange rate regime is also consistent with the longer term policy aim of gaining global currency reserve status for the renminbi.
Leaving aside China's woes, it's worth considering the good news out there – the market was looking at Greece dropping out of the euro (a scenario we thought was highly unlikely) – now all the data from the Eurozone points to a recovery. A couple of weeks ago US data was so strong that it looked almost certain that the Federal Reserve would boost interest rates at its September meeting. We even think that China has the ability to weather the storm – things just might not be as exuberant as some investors thought.
For those worried that things will get worse, it is worth remembering that historically we have rarely seen sustained bear markets (stock declines of more than 20%) without an accompanied recession. What is happening now is more likely a correction – some of it justified in the case of overvalued Chinese equities, but most of it an overreaction that will right itself in the fullness of time.
This content was generated prior to Turcan Connell Asset Management Limited operating as Tcam.