China tests the circuit breaker but not the global markets
The success or otherwise of mainland’s stock market and economy still peripheral to the world and not contagious
I have long claimed that if I am ever honoured with my own economic law, it will be “Harris’ Law of the Quarter End”. This is the long-term observation that market fortunes change on those particular dates. Trends are seen to change abruptly from bull market to bear; from stable to volatile; from one sector emphasis to another.
Naturally, every law has its exceptions – and the exceptions show that often nothing happens over a quarter end. Sometimes market trends bang on for a quarter or two – or extend for a year or more. Sometimes a trend is strong enough to last a few weeks into the quarter (note the many mid-October crashes), or weak enough for a rally to end a bit early, as it did in August 2015.
Exceptions or not, quarter ends provide a witching hour for markets, often driven by options expiries in a sensitive environment, by quarter-end accounting necessities, or by fund managers window dressing their portfolios at the end of a reporting period.
So China opened 2016 by falling “limit down” on Monday and Thursday, as investors regarded a new circuit breaker that halted trading at preset levels as a target rather than a limit. The proximal causes on Monday were the weekend publication of economic figures showing contracting manufacturing activity. Other contributions came from worries that the government’s “national team” would sell shares bought during last year’s market crash and the decline in the yuan exchange rate. Cynics might claim that now that the yuan has achieved a very favourable position in the International Monetary Fund’s Special Drawing Rights basket, the authorities can abuse that position by devaluing.
I would not, as China needs devaluation to assist its stuttering economy. Indeed part of the problem has been the limp response, almost as if by doing so the authorities will lose face. China is not the only country to have managed a transition from developing to developed economy but the authorities give the impression that they are learning on the job, without reference to other countries’ solutions.
Strong-arm tactics to buy the stock market with public money have undermined confidence, and encouraging margin lending to buy shares caused both the big rise and the 43 per cent collapse last year. Interest rates and lending restrictions have fallen insignificantly. Meanwhile the long-overdue clampdown on shadow banks has caused several to collapse, taking investors’ money with them.
Global markets fear contagion from the fall in the Chinese stock market to the world stage. Monday’s 7 per cent fall pulled the rest of the world index down 2.7 per cent and the S&P500 down by 1.5 per cent, not helped by the low holiday-hangover liquidity.
However the success or otherwise of China’s stock market and economy is still peripheral to the world and is not contagious. China’s economic weakness in its role as an exporter to the United States and Europe merely benefits those core engines of global economic growth.
Admittedly, China’s slowdown has hit global growth by undermining commodity prices. Yet cheap commodity prices are very positive for the major economies, including China itself. A healthy Chinese economy and stock market is of course important to the rest of the world – but a struggling Chinese economy currently spurs sustainable global economic growth from cheaper import costs.
The real reason for a bad start to 2016 is the Santa rally that followed the inconsequential US interest rate rise. This resulted in a better fourth-quarter performance after a very weak third quarter, which followed the second-quarter rallies. Perhaps Harris’ Law was working quarterly after all? What goes up must come down – cycles are part of the Circle of Life in the markets.
Investors have many other things to worry about that are more important than China. The developing rows between Saudi Arabia and Iran, Russia and Turkey, Republicans and Democrats, as well as the outpouring of events from the oil price rout, will have more investor impact in 2016 outside Hong Kong and China than sluggish Chinese economic growth.
The principal concern is that stock markets are quite well valued with corporate profits likely to grow only in Asia and Europe. Stock markets move up on expectations for incremental growth – that is growth on growth – not growth alone. The US earnings peak passed in the second quarter of 2015, and equities remain fragile because they are expensive.
The global economy itself does not look as fragile and should provide at least another 12 months of energy. Harris’ Law may well predict a slow first quarter – but not a crash. All we have to fear is fear itself.
Richard Harris is chief executive of Port Shelter Investment Management