Thursday, January 14, 2016

China's stock market casino and the real economy

Esther Teo
China Correspondent

JAN 13, 2016

Will China's stock market turmoil affect the rest of its economy? Only in so far as officials exhibit their ability or inability to tame volatility

BEIJING • While China's real economy is usually viewed as being detached from its markets' wild rides, the latest stock market volatility has stoked fears of a sharper slowdown in its economy and raised concerns over the knock-on effects this could have for its many trading partners.

Chinese shares had their worst start of the year in two decades, with sharp price falls triggering so-called circuit breakers twice last week.

The mechanism was introduced in the wake of a similar crash last August and halts trade for the day once losses reach a threshold of 7 per cent.

However, these circuit breakers were unable to prevent a repeat of the chaos.

Last Thursday, the Chinese stock market fell 7 per cent in just 29 minutes, triggering the circuit breaker and making it the shortest trading day in Chinese history.

The tumult sent global markets plummeting, erasing more than US$2.3 trillion (S$3.3 trillion) off share values last week. The Dow and S&P 500 also had their worst five-day starts in history, falling 6.2 per cent and 6 per cent respectively for the week.


Already China's stock markets are notorious for their volatility, partly due to lax regulatory oversight which has left its markets dominated by false disclosures and rampant insider trading.

This lack of reliable information and transparency creates huge problems when trying to value stocks accurately, with a company's value determined by fear-driven momentum and greed rather than underlying analysis of a firm's real worth.

As a result, shares tend to rise and fall on sentiment and government actions - rather than economic fundamentals - not too different from gambling in a casino, according to many analysts.

Mr Nicholas Yeo, head of Chinese equities at Aberdeen Asset Management, told The Straits Times that share prices in China have little to do with earnings expectations. "It has everything to do with the messy interaction between government market manipulation and the on-again, off-again speculative appetite of millions of small investors," he said, referring to retail punters who drive more than 80 per cent of market transactions.

"Right now, China's onshore markets defy any meaningful attempt at forecasting because share prices don't reflect corporate earnings and are subject to the capricious whims of regulators and small investors alike," Mr Yeo added.


The close connection between politics and economics has muddied Beijing's efforts to let the markets play a "decisive" role in its US$10 trillion economy - a pledge top Chinese leaders made at a key policy summit in November 2013.

The stock market remains a policy lever for the government and share indexes continue to be dominated by state-owned companies.

Listings on China's stock exchanges, for instance, were often politically driven and based on connections.

This led to listings of the most-favoured firms rather than the most competitive ones.

Moreover, many investors - even institutional ones - have a short-term mindset in stock investing because policy directives in China can change so quickly and in arbitrary ways, said Mr Fraser Howie, co-author of Red Capitalism: The Fragile Financial Foundation Of China's Extraordinary Rise.

"The government announces Go West, railway schemes, or Internet plans and those names surge. The government clamps down on certain areas and all of a sudden the brokers are trashed," he told The Straits Times.

This has fostered "get-rich-quick schemes with no long-term thinking and planning", resulting in market swings, Mr Howie added.


These recent bouts of stock market volatility have also introduced another dimension, that of the authorities' clumsy intervention in the markets and a lack of policy clarity.

After a series of unprecedented measures taken to halt last summer's market crash, China's securities regulator proposed circuit breakers that would halt trading for 15 minutes if the markets fell more than 5 per cent, and for the day if it moved more than 7 per cent.

But the band was far too narrow for the wild swings that Chinese markets are accustomed to and, when triggered, the mechanism cut off market liquidity instead, intensifying the frenzy as investors rushed for the door in droves.

It was also ill-timed and was implemented when a share-sale ban that prevented major investors from selling their stock was expiring, further panicking already jittery investors.

Eventually, the China Securities Regulatory Commission conceded that the circuit breakers had brought about "more harm than good", suspending the system just four days after it was first launched.


A string of negative economic indicators such as shrinking factory activity, for instance, has led to renewed concerns, with Beijing's move to guide the yuan lower in recent days only exacerbating fears that China's economy is in for a rougher ride than what the official data is letting on. Some say the pessimism from these economic challenges and the scepticism over whether Beijing has the right policies to deal with them have spilled over into the country's stock and currency markets.

But the bigger question is whether the recent volatility might be a symptom of something bigger and more troubling that could deliver a painful "hard landing" for the Chinese economy.

Some experts such as assistant professor of finance Noah Smith from New York-based Stony Brook University think so.

"The stock market crash looks like... the most visible sign of a much deeper and broader distortion in the country's financial markets", possibly the end of a huge property-based debt-fuelled boom, he cautioned in a Bloomberg commentary View last week.

"If a stock bubble and crash were China's only problems, the danger might not be so great...

"Debt crashes inflict harm on the financial system, creating major recessions that take years to repair," Mr Smith wrote.

Others are more sanguine, noting the disconnect between China's equity market and its economy.

Mr Arthur Kroeber, a fellow of the Brookings-Tsinghua Centre, wrote in a note last July that a big market crash in nations like the United States, where about half the population own stocks and where corporations rely heavily on funds raised on the stock market, can inflict great pain on the economy.

It would slash household wealth and spending, for instance, and also makes it harder for companies to finance their investments.

But China is different: less than 7 per cent of urban Chinese have money in the market, and their equity holdings are dwarfed by their investments in property, wealth management products and bank deposits.

Equity-raising also makes up less than 5 per cent of corporate fund-raising , with bank loans and retained earnings the biggest sources of investment funds instead, he noted.

According to a report by Capital Economics, while China's economy is growing at a much slower rate now, there is also no sign of the more recent, deeper slowdown many argue must lie behind the market falls and capital outflows.

"China's financial markets are in turmoil, but the same can't be said of the economy," it noted.

If anything, it is mostly sentiment and Chinese officials' reputation for competence that have taken a hit amid the stock market boom and bust.

But while the market crash may have a limited direct impact on China's actual economy, it is Beijing's response to the market wobbles that is crucial.

With the country's growth already at its slowest in a quarter of a century, it is the fear that Beijing may also be unable to deal with the slowdown that has the rest of the world worried.

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