Our readers will be aware that it has been the worst start for asset markets since many records began, with the exception of quality government bonds, and gold. US Treasuries have been supported in true ‘safe-haven’ fashion. Having hit the interim 5% and 7% circuit-breakers twice last week, Chinese equities spooked global markets as memories of last summer’s Chinese equity markets’ disaster rushed back, but in reality the real pressure in sentiment terms came from the fear that renminbi weakness very much exceeding expectations will usher in a new bout of competitive currency depreciation. It is just as well that to date it has been difficult for global investors to make direct Chinese investments.
Investors were shocked by last week’s offshore renminbi fall, even though it stabilized at the end of the week. The way we see the renminbi situation is as follows: now the IMF has recently indicated the renminbi will join the SDR basket this year after all, the Chinese authorities want their currency lower, and will try to smooth the fall beforehand. For them, it’s better to have depreciation now (which helps the beleaguered manufacturing sector), prior to SDR basket entry, after which they know prospective renminbi buyers will need stability in that currency if it is to become the true reserve currency they desire. Chinese foreign exchange reserves may have fallen by a record $108 billion last week, but they still remain very large indeed, at $3.33 trillion.
While the Chinese equity markets are as yet not important in a ‘weight of money’ sense (i.e. that in relation to its underlying GDP the market is ‘under-capitalized’, and that de facto Chinese equities are under-owned) international investors are worried that the authorities there simply don’t know what they are doing - and why should they, actually? They are still learning how to be capitalists. The recent Chinese manufacturing PMI numbers (not so the services sector) have been registering continued weakness, and the evidence of this in global commodity prices has gone from bad to worse. Although the official real GDP target remains close to 7%, most sensible economists and market participants have tended to mentally knock about 2% off this figure when discussing what is actually being achieved, but without publishing their true thoughts. In a few conference calls last year we suggested it could easily be another couple of percent lower than that, and we suspect that such a new lower growth range is now becoming plumbed into expectations. Further than this, a so-called ‘hard landing’ in the world’s second largest economy is becoming a distinct possibility, so this is also what the market is really worried about, with the prospect of more exported deflation.
So what is now likely to happen in Chinese markets? We need to have a view on this because if they got the blame for widespread downside across world markets last week, the same could easily happen again. As we go to print, Shanghai and Shenzhen are both down a further 1% or so. The consensus for corporate earnings growth on the Shanghai Composite index suggests a fall of 1.4%, and a rise of 8.7% on the (more tech-weighted) Shenzhen index for 2015, vs. 2014. These Bloomberg-sourced estimates indicate forward P/E ratios of 13.7 x and 32.9 x on the two markets respectively. Can we believe these numbers? Meanwhile, in the real world of demand and supply for stocks, the six month share sale ban by large shareholders was supposed to expire in the middle of last week, but was extended. So of course the potential selling pressure remains, and will still have to be dealt with one way or another.