Why investors are right to be spooked by China
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MoneyWeek Editor
John Stepek Sep 01, 2009
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Markets had a bit of a wobble yesterday. Nothing too serious, but this is becoming a habit.
The Shanghai stock market is now in bear market territory, having fallen by a little more than 20% in the past month. As many commentators have been at pains to point out, this shouldn't really make a difference to anyone else. The Chinese stock exchange isn't terribly representative of the Chinese economy, let alone the global economy.
Yet it seems to have unnerved investors around the world. And maybe they're right to be worried...
Despite its wide following in the media, the Chinese stock market is not a great indicator of – well, anything very important at all. About one in 100 Chinese citizens have accounts with stock brokers, so most people have very little wealth invested in the stock market. As John Foley points out on Breakingviews.com, "China's masses don't buy shares – and its companies don't yet depend on the equity markets for capital." Even more to the point perhaps, is the fact that it's also closed to foreign investors. So it's hardly a benchmark for global sentiment.
My colleague, Cris Sholto Heaton, wrote in more detail about China's economy, and how relevant the stock market is to it, in a recent MoneyWeek Asia email: Is China the next big bubble economy? (if you don't already get his free weekly email, sign up to MoneyWeek Asia here).
Why falls in the Chinese stock market have unnerved investors
But if the Chinese stock market is so unimportant, then why do the recent falls seem to have unnerved investors in other markets? There are a few reasons. For one thing, markets may be looking for reasons to worry. We're heading into a traditionally difficult time of year for equities. Even in good years, returns in September tend to be very poor. And even if you're bullish, you have to admit that the rally since March has gone on for a very long time. The odds of at least a chunky correction are climbing by the day.
Beyond this however, there are other indicators that are more likely to have investors unnerved. There's the slide in shipping rates for one. The cost of renting a capesize ship – the largest type of drybulk ship – is already down 59% from this year's high, according to Bloomberg. And analysts reckon it could fall another 50% by the end of the year. (In case you're wondering, by the way, capesizes are so named because they are too big to fit through the Panama or Suez Canals, so they have to go around the Cape of Good Hope or Cape Horn.)
Anyway the glut has happened for two reasons. For one thing, a record number of new ships will join the global fleet this year. Fearnley Consultants tells Bloomberg that "a record 146 capesizes will be added this year, equal to 28% of the fleet".
This is terrible news for shipping companies of course. They ordered all that capacity during the boom times, and it only gets delivered in time to drive prices lower during the bust. This story gets repeated in every cyclical industry from mining to construction, so it's hardly surprising.
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What China's cutback on imports means for the global economy
But that's only bad for the sector. What's more worrying for the world at large is the other thing squeezing shipping prices – China is reducing its raw material imports, so it simply doesn't need as much shipping space. If China is cutting back on imports, it suggests the global rebound isn't going to be as strong as many had hoped. And that in turn, has an impact on share prices elsewhere.
This also feeds into investors' other big worry – that the Chinese authorities will start to cut back on easy bank lending, and so hit hopes for a government spending-fuelled global recovery. The main reason for the recent fall in Chinese share prices has been a push by the authorities to blow some of the froth off the market. Certain types of lending have been curbed and banks have been asked "to show restraint".
China can save itself, not the world
The point is that China's economy might be able to get through this OK – although even that's questionable, given its dependence on the US consumer. But anyone pinning their faith on the country's ability to drag the rest of the global economy into a rampant recovery is going to find they're disappointed. As Patrick Bennett of Societe Generale tells The Times: "China is saving itself, not the world, even though it is aiding some economies at the margin. Any risk appetite and investment in positions which have been based on the notion of China as the world's saviour have been, and remain, ripe to be unwound."
Add that to the fact that there are so many other worries waiting to confront investors when the bosses get back to their desks after their summer holidays - such as further banking losses on commercial property loans in the States - and it's hard to believe that stocks can continue the rally throughout autumn without at least some upset knocking them back.
Indeed, in his latest Model Investor email, MoneyWeek regular James Ferguson points to another key signal – apart from the slump in the Chinese stock market – that global stocks are set to roll over. Yields on US government bonds started on a rising trend (ie prices started to fall) about two months before this stock market rally began, as investors became more confident about leaving the safe haven of Treasuries, and started to fret about inflation.
But now US Treasury yields are in a falling trend again (therefore prices are rising). If equity markets follow suit, then stocks are likely to be in a "new downtrend by mid-October, if not earlier". (Read more from James here).
We've said it before, and I'll say it again now - defensive stocks still look the best way to play the market for now.
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