The Chinese domestic stock market has fallen by over 16% this week (at the time of writing) on the back of currency devaluation and ongoing anxiety about valuations. The falls have now twice triggered a suspension in trading. This follows the dramatic market ups and then downs last year in China which required massive state intervention to stabilise. Arguably this was counter productive as it kept values at an artificially high level which is now unwinding.
The key question for our clients is will a sneeze in China now lead to us all catching a cold – are our own portfolios and economy closely correlated with China in the same way as they look to be with the USA and Europe?
The Chinese domestic stock market is very much a local market and is difficult for external investors to put money into. Our portfolios have little or no direct exposure to it. Market sentiment is a much bigger factor in China than elsewhere due to the large numbers of new small investors who came into the market when it was going up.
The Chinese economy is a different matter in that it has become an increasingly important part of global trade. Chinese growth has been one of the major planks of global growth over the past 20 years. That growth has slowed in percentage terms but this was inevitable. Smaller percentage growth figures but on a larger economic base still mean growth is huge.
China is looking to change direction away from infrastructure and industrial growth and move to more of a consumer led and competitive economy. This has had a direct effect on commodity prices, emerging markets and as we have seen here in the FTSE, the value of mining companies. Emerging markets have also been hurt by both the devaluation of the Chinese currency and the increase in the US dollar.
However, the volatility we have seen in Western markets this week is not just because of events in China. We have seen a long bull run in risk assets since 2009, in part due to very loose monetary policy from central banks and unprecedented amounts of quantitative easing. The potential end of that policy and perceived high asset prices mean that markets are easily spooked, sometimes by relatively small events when viewed globally. Markets do not like surprises which means unpredictable actions by the Chinese state tend to have exaggerated effects.
So in summary, this year is likely to see plenty of volatility and perhaps the further extension of low interest rates as a result. Chinese and other sneezes will continue to effect global markets in the short term and we are at a bit more risk of catching a cold than we would be at a different stage in the global cycle. Holding a diversified and well run portfolio with an eye toward long term returns rather than short term fluctuations remains the best approach.