How to fix China’s economy? Investors are unsure and that’s a problem
- Investor sentiment around China’s prospects has remained sour despite a significant increase in the pace and scope of policy support for the economy
- This discrepancy suggests China’s problems are too complex and multifaceted for global investors to grasp
The relationship between the real economy and financial markets is never straightforward, mainly because there are many factors other than growth that influence asset prices. An oft-cited adage on Wall Street is that the economy and the stock market are not the same thing.
In developing countries, where the policymaking process tends to be more opaque and capital markets are not as mature and liquid, measures of investor sentiment are an even less reliable gauge of the state of the economy and where it is heading.
The combination of a stabilisation of the economy and more stimulus ought to provide some comfort to markets. However, foreign investors have sold US$23 billion of mainland Chinese equities via the Stock Connect scheme in the past three months, the largest withdrawal over a three-month period on record, according to HSBC data.
However, the fact remains that China still has the capacity to surprise markets positively, as it did late last year. As recently as April, respondents to Bank of America’s monthly global fund manager survey were still quite bullish about the prospects for growth. Even today, China’s economy does not figure among the top “tail risks” in markets.
A more compelling explanation is that nothing Beijing does in terms of policy will be sufficient to turn sentiment around for the simple reason that investors are at a loss as to what needs to be done to restore confidence in China’s economy.
In advanced economies, bad economic news is often treated as good news for markets because it increases the scope for stimulus, buoying asset prices. In China, the link between economic data and policy support is much more tenuous.
China’s economy is bottoming out, but that’s no reason to cheer
Crucially, China’s problems are structural, not cyclical. It is hard enough for policymakers to decide how best to counter the property-induced downturn while avoiding more severe financial turmoil, never mind ill-informed foreign investors who have enough problems assessing and pricing risks in advanced economies.
What is clear is that foreign sentiment towards China is a poor predictor of where the country’s economy and markets are heading. This does not mean that the bearishness is misplaced. It simply means the economic problems facing China today are too complex and multifaceted for global investors to grasp. This could explain why China is not at the top of global fund managers’ list of concerns.
Nicholas Spiro is a partner at Lauressa Advisory