China: Easy come, easy go
Craig Farley, fund manager at Ashburton Investments takes stock of recent equity market volatility in China and assesses the impact this may have for the second half of the year.
The wild gyrations witnessed in Chinese equity markets this year are further evidence – if any were needed – of the schizophrenic sentiment that punctuates the investment climate in the world’s second largest economy. As we write, Shanghai’s domestic A-share market has corrected over 32% from the June 12th 2015 peak (following a spectacular 18 month rally of 145%), forcing regulators to scramble for conventional and unconventional policy measures to stem the massive sell-off.
Although impacted less severely, H-shares (Chinese stocks listed in Hong Kong) have inevitably been caught up in the storm, falling some 26% from the May 26th 2015 peak.
To assess where markets stand and where we might go, revisiting the road travelled is often a sensible place to start. Looking at the chart below of Shanghai listed A-share and Hong Kong listed H-share market performance since December 2013, two observations are immediately apparent; 1) the dislocation in performance that began in September 2014 following a period of high correlation between the two markets (which extends back to 2010), and 2) the outsize performance of China’s domestic A-share market, particularly in the melt-up phase during the second quarter of 2015.
Winding the clock back to the third quarter of 2014, Beijing officials were confronting an increasingly challenging environment – tolerating a slower economic growth path trajectory whilst transitioning to a more consumer orientated model in the face of a quicker than expected slowdown in the economy and potential need to stimulate. A slew of weak economic data points in September 2014 (purchase manufacturing index, trade imports, money supply, fixed asset investment and retail sales) accompanied by a broad housing price downturn was the straw that broke the camel’s back. Beijing blinked late in the month, with regulators formally announcing a plethora of measures to support the housing market, including cuts to the first time buyer’s mortgage rate and re-categorising second home mortgages as first mortgages, where the first mortgage is fully repaid.
A surprise People’s Bank of China (PBOC) interest rate cut followed on 21 November 2014, accompanied by draft regulation proposed by the China Banking Regulatory Commission (CBRC) aimed at reigning in the shadow banking industry. The message was clear: China had essentially moved from its stated posture of ‘targeted easing’ during 2014 to accommodative monetary policy in an effort to stabilise growth. Investors viewed still-tight real monetary conditions as a recipe for the authorities to engage in a more virtuous easing cycle, in essence perceiving a ‘Beijing put’. Through the first half of 2015, this has played out via a combination of conventional policy measures and rhetoric, specifically:
Further interest rate and reserve requirement ratio cuts
An announcement by PBOC Governor Zhou the March National People’s Congress meeting that it was ‘highly likely’ China would deregulate deposit rates completely by the end of the year
Confirmation that the People’s Republic of China (PRC) will allow banks to swap their local government financing debt for municipal bonds – a move aimed at reducing the systemic risk posed by the banking sector
Development of the Shanghai-Hong Kong stock Connect, enabling Hong Kong and international investors to access the Shanghai-A share market more freely
Relaxation of A-share account opening requirements, enabling multiple account openings by individual investors
In addition to the above, the Chinese government vociferously championed a bull market in equities, promoting both the benefit of a strong capital markets to the economy and the A-share market as an alternative investment channel to more traditional channels such as property and, more recently, Wealth Management Products. Media channels also alluded to the potential inclusion of China within global indices, including MSCI and the IMF looking favourably on the renminbi’s addition to the Special Drawing Right’s currency basket later this year. Domestic retail investors rushed to buy, culminating in a market melt-up. By the peak in mid-June, the extent and nature of the Shanghai A-share rally in 2015 alone had added the equivalent of US$ 4.1trillion in value, equivalent to 37% of GDP.