Justin Urquhart Stewart

Screen Shot 2016-04-19 at 10.11.46So what’s China go to do with you?

By Justin Urquhart Stewart,

“Well it’s over there, not here, and after all every stock market has to go through a crash or two as they grow up” – is not a very helpful way of looking at what has happened to the overblown Chinese stock markets. Over recent years the two mainland stock markets and their indices, the Shanghai and Shenzhen markets, have frankly borne more resemblance to a gambling den rather than investment markets.

As the Chinese have developed their own blend of “Capitalism-Lite”, which allows a single communist party regime to operate in a more capitalist structure, we have seen many of the market economy traits, both good and bad, of the trading world develop inside China. From wealth creation to wealth inequality, from entrepreneurship to unemployment, from increased well-being to record numbers of civil riots, China has become a congress of contradictions.

However due to its size, its influence and the effects of these contradictions, its impact spreads far further than the hyperbole of the investment headlines around stock market crashes. The Chinese economy by most measures is probably the second largest in the world after the USA, some argue that it is in fact now the largest, but I think one of the key measures is the spending value of its populous. If you divide the US economy by its population you still get quite a big number: do the same with the vast Chinese population divided into their economic value and you end up with a figure comparable with the less than dynamic Jamaican economy.

Its size and influence now though is ubiquitous around the globe, and thus its effect will resonate around every nation to one degree or another.

With gains of over 120% in a single year certainly the mainland exchanges saw dramatic gains, but this was not due to the exploding value of the economy or even just revealing underlying value of its companies, but rather down to the increased ability for the Chinese to bet and then increase their wagers on the Chinese betting shops known as the stock exchanges. The potentially dangerous trading practise of “margin trading” in many markets can be very destructive in the wrong hands. The ability to borrow against your assets and effectively leverage up your bets on the markets, can be very exciting on the way up, but financially lethal on the way down, where forced sellers struggle to pay their margin calls as prices fall, and their exiting merely encourages more desperate sales, and so a deadly financial vortex sucks down both the value and its investors still further.

 

The reality is that there is usually nothing you can do in the face of such losses except suspend trading for a while. However even this can serve only to possibly calm short term panic, but the value will still fall until the market finds a level where brave investors start to buy in to establish the real current value.

The broader damage occurs more subtly elsewhere, as a falling market drains the vital word for any economy – confidence. Thus as values and confidence seep away like water into sand, so will the desire and ability of certain companies to take investment risk elsewhere. This as we have seen around the globe has been vital for the Chinese as they seek to buy assets further up the development line of sophistication. In the UK for example, the desire to try and get the Chinese interested in our infrastructure projects has been almost embarrassing as seemingly everything from trains to power plants appears to have some Chinese investment involvement. Thus if the domestic valuations are being eroded away then so too will the desire and wish to invest overseas, and thus many heavily indebted western nations will struggle further to sustain the slowly recovering economies.

However the effects of the Chinese market falls go further still and affect nearly all of us personally. A quick look in our pension schemes will often reveal a significant range of good quality UK blue chip companies, called such if only because they are quoted on the FTSE 100 index. Now whilst there is nothing wrong with that, we find in fact that the UK FTSE100 index is in fact heavily weighted towards certain sectors and that includes the mining sector with names like Anglo American, LonMin and Rio Tinto – all of which are quoted in the UK but all of which mine elsewhere around the globe. Not only that but often the primary customer for their products is of course China and its still growing (albeit at a slower pace) economy as the dragon continues to devour more raw materials.

Thus there is a direct effect from a slowing Chinese economy whose confidence is further undermined (apologies for the pun) by falling investment valuations.

The mining companies over the past decade have basked in the light of the much hyped “commodity super cycle” which promised the ever growing wealth of the miners as the demand for their rocks and ores proliferated. Now the wheel has come off this super cycle and we have seen over the past year some dramatic fall backs in the value of these mining shares and have certainly held back the potential for their index, the FTSE100. So for all of us even with a FTSE100 tracker in our pension let alone some BHP Billiton shares, we have all been affected by the Chinese slow down and market slump.

So what has the Chinese stock market slump got to do with you? The answer is a lot. From the effect on Chinese confidence and potential overseas investment, to diverting resources domestically within China rather than overseas, to affecting the value of inward investment into our own economies, to affecting the value of our own pensions, ISAs and investments with those China related stocks – yes we are all impacted.

So what to do? Remember we live in an economic cycle. China will still grow albeit slower for the moment, but the cycle will turn and values will improve. So ignore the noisy headlines of Chinese stock market firecrackers, and look through to a slow but growing economy where China will eventually find more stable valuations, for its indices, its economy and my pension.

Justin Urquhart Stewart / Copyright Merlin Publishing 2015