Putting China in Perspective


The precipitous fall of the Chinese stock market in the initial trading days of 2016 has certainly resulted in a degree of shock and awe across the globe for investors. While the pace of the decline in prices of the stocks of Chinese companies trading on the local Chinese stock exchange, and the associated impact on other global stock markets, was similar to what was witnessed in August of 2015, there are some complicating factors this time around that investors should take into consideration as they build their portfolio strategies for the New Year.

     1.    As a result of the dramatic volatility in their stock market (which we should remember is only 25 years old) in August, Chinese regulators imposed circuit breakers to help stave off significant daily declines. The circuit breakers that were implemented involve a 15 minute halt of trading when the Shanghai Shenzhen CSI 300 (CSI index) drops by 5% and an early market close when the CSI index falls by 7%. Given the volatility of the Chinese stock market, many are suggesting that this circuit breaker band is too narrow and perhaps is contributing to dramatic, short-term volatility that took place on Monday and Thursday of this week, remembering that these new circuit breakers were just put into place on Monday. As a point of contrast, the New York Stock Exchange’s circuit breakers currently in place do not call for an early market close until the S&P 500 index has fallen by 20% within a given trading day. As of this writing, we understand that the Chinese regulators are now considering suspending these new circuit breaker rules. In general, more change = more uncertainty = more volatility.

     2.    The ban on the selling of stocks by insiders of their companies was put in place by Chinese regulators after the August rout is scheduled to be lifted this Friday. This has led some Chinese stock investors to speculate that there may be pent up selling pressure resulting in these insiders selling shares when the ban is lifted. Hence, some are looking to sell their shares ahead of the potential opening of this floodgate.

     3.    The People’s Bank of China (PBOC) has essentially allowed the Yuan, China’s currency, to devalue. A weaker Yuan helps with China’s exports but essentially hurts the Chinese population by making imported goods more expensive for them to purchase. This currency policy suggests to us that the Chinese government is looking to increase exports as a means by which to grow their economy or perhaps engineer a “soft landing” for their economy that has purportedly experienced record growth over the past decade only to slow down in recent years. Whether this policy is successful or not will not be known for some time (i.e. at least a few quarters, not a few days), but many Chinese investors may not be too optimistic as a result of the selling that is taking place on the Shanghai. This policy is also suggesting to others that they have more concerns about their economy than they are letting on.

To put the above into perspective, we should also examine the underpinnings of the global economy to see if these events in China, in and of themselves, could cause a global economic slowdown or even a global stock market crash.

1.   It is fair to suggest that China is a vital worldwide trading partner and major contributor to worldwide Gross Domestic Product (GDP) growth. As a result, if the Yuan remains weak and Chinese citizens do not purchase as many imported goods as they did previously, this could translate into a cut in earnings of multi-national companies who derive a large percentage of their revenues from China. On the other hand, if the Chinese government is successful with their currency strategy and a pick-up in exports helps to renew growth in their economy, this could translate into greater job opportunities and associated income available for Chinese citizens to spend down the road. Additionally, stabilizing and growing developed market economies may be able to help minimize some of the sales declines that could be attributed to the Chinese economy.

2.    The U.S. economy, while not knocking the cover off the ball by any means, has stabilized and we anticipate that it will grow this year by an annualized rate of somewhere between 2.4% – 2.8%. This forecast is consistent with our longer term forecast of sub-3% annual GDP growth in the U.S. for the next 5 years. The Federal Reserve (Fed) is also apparently comfortable with the current state of the U.S. economy based on the initial rate hike that took place in December of 2015 and their stated position of looking to employ a more gradual path to higher rates going forward which may result, in our view, in 3 – 4 additional rate hikes, in 25 Bp increments, in 2016. Nothing that has happened during the first week of January suggests any deterioration in U.S. economic growth sentiment. To the contrary, the first Initial Jobless Claims report of the year showed a decline of 10,000 claims to 277,000 total claims for the week ending January 2, 2016. Additionally, consumer confidence, as measured by the Bloomberg Consumer Comfort Index, rose to 44.2 for the week ending January 3, 2016. This marked the 5th straight week of increases and has the index at its highest level since October 11, 2015. We will continue to closely watch this Index to see if confidence erodes as a result of what is transpiring in China, and to a lesser extent, across the world.

3.    The European economy, which is still at the beginning stages of their economic recovery and also is not knocking the cover off the ball by any means, has shown signs of life which we believe will be further intensified by additional stimulus measures on the part of Mario Draghi and the European Central Bank (ECB) in the New Year involving some form of interest rate cuts or quantitative easing increases. In fact, due to increased efforts to stimulate their respective economies, and a U.S. Dollar which should only get stronger in 2016, we anticipate Europe, and International Developed Markets as a whole, outpacing the U.S. stock market in USD terms in 2016. Nothing has changed during the first week of January to these underlying economies that would cause us to change this outlook at this time.

While we are somewhat surprised by the global market reaction to what is transpiring in China thus far in 2016, based on a similar situation that transpired during August of last year and the lack of any other concerning economic data reports that have been released to date in January, we do think that all of this volatility serves as an important reminder to investors. It should remind investors of the importance of asset allocation in their portfolio strategies. These portfolio strategies should always be constructed in accordance with one’s investment objectives, investment timeframe and tolerance for risk. While past performance cannot guarantee future results, and asset allocation cannot ensure a profit or protect against a loss, applying a historical perspective and maintaining an appropriate strategic asset allocation can help provide comfort and direction to investors during periods of great volatility.

We also believe that the PBOC, not known for being as communicative or transparent as the Fed or the ECB, will continue to explore ways to stimulate their economy and stabilize their stock market. Some of these methods may prove successful, while others may not. Regardless, investors may soon either be comforted by newly announced measures from the PBOC or come to the realization that the overall gradual global growth story heading into 2016 remains the same (at least for now) after the first week of January. This could lead to some form of a bounce and stabilization in global, developed stock markets after some additional market volatility is experienced in all global stock markets, notably the emerging market of China. Volatility, and intermittent starts and stops in the stock market, may very well be the story of 2016.

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