The Great Fall of China?
The wild ride of Chinese stocks has many investors concerned. Daily movements resemble those of global equities in 2008—up 5% one day and down 5% the next, with volatility that could make any investor cringe. Over the last year, Chinese stocks have straight-line soared over +100%, but in the last month have suffered a precipitous drop of over -30%. Along with the escalation of the Greek crisis, it’s tempting to view these events as the potential dismantling of the global bull market. Investors who argue that the global economic expansion was already weak, may be ready to head for the exits. I’ve argued before that I see the Greece situation as a false fear – Greece is too small to impact the global economy, and financial markets in Europe appear poised to prevent contagion. A spot-check of yields in Spain, Portugal, and Italy (other potential at-risk countries) – which remain nicely low – shows the market isn’t too concerned. My line of thinking on China is similar. While China’s economy is most certainly big and important enough to disrupt – or even reverse – the global expansion, its stock market is not, at least in my view. Here's why. Chinese Shares Aren’t as Volatile as Investors Think There’s a big piece missing from the Chinese ‘stock market mania’ narrative, and it’s probably the most important part of the story – explaining how China’s equities markets actually work! The basic premise is that Chinese equities are divided into A-shares and H-shares. A-shares are available for trading almost exclusively by Chinese investors, meaning that the market is missing two critical components of efficiency: maximum liquidity and global participation. It follows that A-shares have virtually no correlation to global markets—one zigs and the other zags, one soars while the other only nudges higher. It’s the A-shares that are creating all the hubbub in the press. Over the last year (through July 14), A-shares climbed almost +150% through June 12, then fell nearly 35% to their low on July 8. That’s the type of market activity investors are wise to avoid. Chinese H-shares are a different story, and they matter more for the narrative. H-shares trade on the Hong Kong exchange, which is an open market where international investors can participate. The difference in the market action is astounding: H-shares went up a little over +40% to a peak on May 26, and have fallen about 20% over the last month or so. That’s eyebrow raising volatility, but it’s not an Armageddon-like swing many are now associating with China. If you look at global stocks over the same period, you’ll notice that they have virtually no resemblance to Chinese equities, A-share or H-share. The MSCI World is essentially flat over the last year. The Bottom Line for Investors China has already had two bear markets since 2009 when the global expansion and bull market began. Yet, neither one managed to derail the course of global growth and the stock appreciation that’s followed. I do not think this Chinese ‘bear’ is set to break that pattern. The Chinese economy is still set to grow 7% this year (recent figures show it just expanded right at 7% year over year), which is a huge, positive contribution to global GDP. Additionally, the People’s Bank of China has demonstrated a willingness to cut interest rates, and stimulate the economy, which should ultimately bode well for stocks in the medium term. What I believe is a negative is the Chinese government’s intervention in the equities markets in an attempt to stem the sell-off and keep investors in risk assets. Government action to cap short-selling, to halt IPOs and force companies to submit share buyback plans, are intrusive and disruptive to natural market forces. The more interventionist China’s government becomes, the more bearish I get on Chinese stocks. At the same time, the government has almost always been involved one way or the other, so this is not a new or unexpected shock to markets. At the end of the day, investors would be wise to own a portfolio that’s globally diversified enough to absorb these swings in China’s market. Still, it’s not as bad as it may look. However, it also raises a key question: Is it time to tread lightly with international stocks? With China being a huge economy, will this eventually affect the global market? Also, with all of the Greek drama, should the Puerto Rico muni bond slide and the China growth stimulus timeline make us think bearish? What are Key Investment Strategists Saying Privately? Before you make any changes to your portfolio, I suggest that you check out our outlook for economic growth (both foreign and domestic) and comb through the industry rankings in Zacks Consensus Market Strategy: Forecasts of Future Asset Class Returns. This report, updated for July 2015, brings you a consensus of predictions from some of the world's most respected strategists, economists and buy-side CIO’s. It could help catch portfolio-impacting trends before they develop. Free Download - Zacks Consensus Market Strategy: Future Asset Class Returns - July 2015 Best Regards, and Better Returns! —Mitch
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