China Crisis

China Crisis

August 27th, 2015

The perfect storm

Nick Mustoe, chief investment officer at Invesco Perpetual, explains how China’s stockmarket slump stems from a number of factors coming together to create a perfect storm

While global equity markets have been jolted by China’s decision to devalue the yuan, a number of things have come together to create the perfect storm. China’s economy is certainly rebalancing itself after having been the pillar of global growth in recent years. Making the adjustment to more normalised levels of economic growth smoothly is proving to be difficult and, as such, the global equity market reaction has been very pronounced.

To recap, there was a big share price correction in China’s domestic A share market a few weeks ago following an excessive climb in share prices earlier this year, peaking in late April. Investor sentiment was extremely bullish and individuals were encouraged by the Chinese authorities to invest in the stockmarket – often for the first time – creating a sizeable bubble. While initially seen as a domestic China story, the bubble has since deflated rapidly. It ricocheted into the Chinese H share market (which is available to international investors), before spreading to the rest of Asia and beyond.

“The Chinese authorities’ clumsy manner in bringing about the devaluation of the yuan has been taken as a signal for panic by financial markets.”

Where this was considered a sideshow not so long ago, the People’s Bank of China decided to weaken the yuan against the US dollar in recent weeks in a bid to fend off lower economic growth. Weaker economic data, including falling exports (down 8.3% in July, compared with a year ago), seems to have driven the Chinese authorities to take a very heavy-handed approach. Their clumsy manner in bringing about the devaluation of the yuan has been taken as a signal for panic by financial markets.

In my view, however, the action by China’s policymakers could be read as a warning signal, though it will fundamentally not make much difference to the outcome. Combined with broader emerging market weakness and sliding commodity prices, ‘risk-off’ market sentiment has come to dominate.

Prior to the move to devalue the yuan, markets had already been fretting over the timing of the first interest rate rise from the US after almost seven years of being at a historic low of more-or-less zero. But the slowdown in China (many believe China’s official 7% economic growth rate is an overstatement) and the attempt by the Chinese authorities to stimulate exports, have created a downturn in all equity markets.

The US S&P 500 index, for example, has seen its biggest two-day decline (as at 15:50 on 25 August 2015) since 1 December 2008 (source: Bloomberg). Symptomatic of a true market over-reaction, the prices of gold and US treasuries, meanwhile, have rallied.

To my mind, there has been an element of ‘necessary correction’ given how fully valued some areas of the stockmarket have been. Against this backdrop of indiscriminate selling, at Invesco Perpetual, as long-term fundamental investors, this has created a buying opportunity for where we see pockets of value in share prices globally. I have a positive outlook on Europe, for example, where we see good grounds for the domestic European recovery to continue.

China’s economy is rebalancing, certainly, and I believe it will continue to slow, but this is not necessarily the start of a global recession – despite what the pronounced market reaction may suggest.

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