Geoff Cook Chief Executive Officer From Jersey Finance

Tumbling stock markets around the world have triggered a resurgence in the debate about the sustainability of China’s economic performance. So what does the future hold?

Chinese intervention to prop up the Shanghai stock exchange has fuelled speculation about economic growth running out of steam and after failing to slow the rout the authorities have stepped back.

So, is this a conventional market correction with prices running ahead of fundamentals, or something more serious?

My view would be it’s a technical market correction. Here’s why:-

Investment into Chinese mainland markets, already strong, was further buoyed by the Stock Connect “Through Train” at the end of 2014, giving Hong Kong based investors access to the Shanghai market and vice versa, but the early flows were nearly all inbound, as investors chased the China growth story.

Recent news of a moderating in economic growth (already planned by the authorities due to concerns about asset bubbles) saw the Shanghai exchange retreat by 30% propelled by investors fears around their highly geared holdings. Almost nothing is guaranteed to induce instability in stock markets more than watching prices fall below the value of loans used to pay for them.

The Chinese authorities have an interventionist record, it is after all a social market form of capitalism, but markets are not a mathematical laboratory, and it seems China has conceded that the wall of cash needed to prop up an entire market when the world is watching, is beyond any single country. Investors used to seeing share prices propped up, have panicked.

China is transitioning from a double digit high growth emerging market to the world’s leading economic power, and the Chinese authorities had already signalled a move to a more sustainable growth trajectory to head of price bubbles. The current market gyrations are part of the transitioning to this new economic state and will allow a reset of valuations to more sustainable levels.

However, the China growth story is still intact.

The recent renminbi devaluation will make Chinese exports more competitive and kickstart the economy. In 2014, China overtook the US in terms of world GDP ( just over 16%) and now has a bigger share of trade with more countries than the US. If China does decide to intervene in markets, it has enormous firepower, with reserves of some $3.7trn. Speculators will now be less confident of automatic market support and this should dampen volatility.

Governance is improving dramatically, Xi Jinping’s anti corruption drive has seen more than 600,000 officials disciplined or indicted, rooting out corruption, and strengthening Xi’s hold on power, as the Chinese people see action on one of their biggest concerns.

Chinese economic performance is not all about domestic share values. With more than $20bn invested in Africa each year and the launch of the Asian Infrastructure bank, Beijing has signalled its global ambitions, and will continue its inexorable march to No 1 world economy status.

Global stock markets have been inflated by Central banks ultra low interest rate policies and unless there is some policy intervention, then prices will need to go lower to bring prices back in line with market fundamentals.

With the FED predicted to move on interest rates sooner rather than later, and the liquidity prop of QE gradually removed, the inflation of markets by public policy measures appears to be coming to an end. We can expect a bumpy ride to the new normal, but this doesn’t alter long-term fundamentals. China will not fall and it’s resilience will surprise on the upside.

IMAGE: China broken map.jpg

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Related story:

Bad for China, Good for European Stocks

By: Ashley Kindergan From The Finanacialist

For the three months leading into August, the Chinese government had kept the yuan-dollar exchange rate fixed in a tight range around 6.115 yuan to the dollar. Yet the yuan’s spot price consistently traded about 1.4 percent weaker than the fix. Investors, in other words, sensed a devaluation coming. In mid-August, Chinese officials proved them right by intervening in currency markets for three days in a row, prompting a 3 percent drop in the value of the yuan.

An 8 percent decline in Chinese exports in July likely served as the immediate catalyst for the intervention, Credit Suisse economists say. Since the yuan is pegged to the dollar, which has appreciated 19 percent on a trade-weighted basis over the past year, the trade-weighted value of the yuan has been rising as well. Combined with rising labor costs, the rising value of its currency has made China’s exports increasingly uncompetitive.

Michael O’Sullivan, the Chief Investment Officer for the United Kingdom, Eastern Europe, the Middle East, and Africa for Credit Suisse’s Private Banking & Wealth Management division, sees another motivation for the intervention as well. China’s currency moves echo events in the United States circa 1927, when Benjamin Strong, then the governor of the Federal Reserve Bank of New York, convinced the Board of Governors to cut interest rates from 4 percent to 3 percent, despite a high level of speculation in U.S. equity markets. Strong wanted to revive the stock market, weakened by a real estate bubble in Florida. He called the rate cut a “coup de whiskey” for American stocks – a chaser shot to get the party going.

The parallels are difficult to ignore. Chinese property market values rose for a third consecutive month in July, but only after a year-long decline. As for speculation, Chinese retail investors borrowing money to buy stocks fueled a tremendous rally in the first half of 2015. Since the recent currency intervention is too small to benefit exporters in any meaningful way, it seems that Chinese officials hope, as Strong did, to revive the investor confidence that helps drive financial markets, which at this point are playing a major role in the country’s GDP growth.

In 1927, Strong succeeded in engineering a significant rally, but the crash of 1929 wasn’t far behind. And while O’Sullivan believes that China’s devaluations have raised the troubling notion that the economy may be even worse-off than investors imagined, he does not believe the country will endure a hard landing. “To their credit, the Chinese manifestly do not want to end up like the U.S. in the 1920s,” he says.

For that reason, O’Sullivan does not foresee further devaluations ahead, not least because the Chinese government must also be concerned about capital outflows. In June and July, the People’s Bank of China and other banks sold a net total of 342.8 billion yuan ($53.6 billion) worth of foreign currency. Because much of the overseas cash that comes into China is ultimately sold to the central bank, many economists consider the net sales figures a good indicator of total capital flows. The recent bout of selling pushed short-term interest rates higher, and in response, the People’s Bank of China poured 120 billion yuan ($18.8 billion) into the financial system August 18 in the form of short-term loans to commercial banks. O’Sullivan believes that Chinese officials will now return to conventional means of stimulus such as cutting interest rates and the reserve requirement ratios.

So what are the implications of China’s intervention beyond its borders? For starters, because the yuan heavily influences regional exchange rates, China’s devaluations have hurt other Asian currencies as well. The Indian rupee, Indonesian rupiah, and Thai baht fell 2.7 percent, 2.6 percent, and 1.4 percent, respectively, against the dollar over the past week.

For big trading partners, the devaluations will make Chinese imports cheaper, creating a risk of imported deflation, including in the U.S. And although that deflation risk could conceivably affect the timing of the Federal Reserve’s interest rate hike, Credit Suisse believes the central bank wants to get on with it badly enough to pull the trigger in September.

Falling prices are a touchier subject for Europe, where the economic recovery is still nascent and fears of sustained deflation prompted the European Central Bank to introduce a bond-buying program earlier this year. If a believable specter of deflation reappears, the central bank would almost certainly extend its commitment to quantitative easing, while economies outside the Eurozone, such as Sweden, would also likely opt for easy policy. The ECB might even add to its stimulus, depending how much further the yuan weakens. At a time when the Federal Reserve and Bank of England are ready to tighten, relatively loose policy would make European stocks attractive.

So did you follow that? This is how the butterfly effect of the global economy works these days: China devalues, European stocks look more attractive. They’ve even got a few arguments in their favor that have nothing to do with monetary policy. Fifty-eight percent of European companies that have announced second-quarter earnings have beaten expectations, and investors have also poured $1.3 billion into exchange-traded funds that track the EuroStoxx 600 index over the past month. Small-cap European stocks, which are less exposed to China than large-caps, merit particular attention. Because if the Chinese economy slows much further…another butterfly might take wing.

IMAGE: yuan euro

For more on this story go to: http://www.thefinancialist.com/bad-for-china-good-for-european-stocks/#sthash.9MOgE7jG.dpuf