Investors’ appetite for China’s stock market is quickly unwinding. Since the peak almost one month ago the Shanghai Composite Index lost a third of its value. Just like there were no fundamental economic reasons that could explain the earlier steep increase in stock market prices, the current crash has not been triggered by worries about an imminent hard landing. While we would certainly not dismiss this risk as futile and also think growth will slow down faster than consensus estimates, the impact on economic activity looks set to remain fairly modest.
Since the start of the equity rally last summer until its recent peak almost one month ago, Chinese stock prices more than doubled. This sharp upward move always looked suspicious given that economic activity continued its downward growth trend. Looking forward, economic growth in China will continue to decrease from current levels. The fast rise in income levels seen over the past decades (limiting the country’s future catch-up potential), the rebalancing of the economy towards consumption away from investment and China’s rapidly ageing population will all play an important role in this.
Admittedly, this does by no means imply that equity prices should have moved in the same negative direction. First of all, it can be argued that China’s stock market was far from expensive one year ago. Indeed, traditional valuation measures including the price/earnings ratio or the market capitalization of listed firms relative to GDP both suggested in fact the Chinese stock market had become fairly cheap. Moreover, despite slower growth, the rebalancing of the economy is a positive evolution and one that makes future growth more sustainable.
At the same time, however, there were also several reasons to be sceptical, certainly in times when Chinese policymakers are experiencing difficulties in trying to make sure that growth doesn’t slow too abruptly. Importantly, it cannot be denied that a lot of (official state) media attention has been given to the attractiveness of China’s stock market while policymakers were putting further rebalancing measures in place. In other words, Chinese leaders have interpreted rising stock market prices as evidence that their strategy was playing out fine and have not refrained from underlining this. Moreover, the fact that the housing market was struggling at the same time has also helped to drain savings into China’s stock market. All this in combination with the prospect of more capital account openness (including bigger representation of Chinese stocks in global equity indices) has fuelled a speculative stock market bubble.
Since its peak mid-June, the Shanghai Composite Index has fallen by around 32%. Year to date, however, the index increased more than 8%. Over the last 12 months, meanwhile, equity prices are still up more than 70%. The big challenge and difficulty of course is to see what comes next. Authorities are now taking measures to support the equity market. What’s also obvious is that this is proving very difficult, especially when at least a significant part of the money invested is debt-financed. All in all, for reasons explained here, the impact on overall economic activity should remain fairly limited at this point. That said, recent turbulence once again underlines how difficult it is for Chinese leaders to deal with the huge imbalances stemming from the unsustainable credit boom witnessed after the 2008-2009 crisis.
Hans Bevers is economist at Petercam