CAUSE FOR CONCERN: CHINA’S PANIC SHOULD GIVE INVESTORS PAUSE

The Chinese government’s response to the steep decline in Chinese equity prices over the second half of 2015 is concerning. In response to falling stock prices, the Chinese government took a number of, by Western standards, drastic steps to stanch the bleeding. These steps included, but were not limited to, lowering interest rates, suspending IPOs in order to force investors to focus on listed companies, threatening with prosecution short-sellers and journalists who spoke negatively about the Chinese stock market, devaluing its currency and sponsoring the purchase of equities in a failed attempt to prop up prices and closing their equity futures market. In short, the Chinese government panicked, and its actions only added to market volatility as international investors became uncomfortable with its meddling and pulled capital out of Chinese stocks.

These events are concerning because the Chinese government had been steadfast in its claims that it would allow markets to behave with minimal government intervention. Yet, in the face of a downturn, the government attempted to intervene in a blunt and troubling way, potentially signaling that it lacks the sophisticated tools and discipline to respond appropriately to adverse economic data and to spur growth. An example of why this is concerning is the fact that China has used spending on infrastructure as a primary lever in GDP growth.  One comparative statistic is dramatically telling:  China has poured more concrete between 2010 and 2013 than the U.S. poured in the entire 20th century.[1] When this infrastructure spending lever’s efficacy wanes, the government must be able to use more sophisticated tools to manage its economy.

Until we see proof of the government’s ability to more effectively manage its economy, our expectations for China and emerging market equities remain tempered, and we believe that investors should remain cautious when considering investing in China.

 

[1] Summers, Lawrence, The Global Economy is in Serious Danger, The Washington Post, October 7, 2015.