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Craig Stephen's This Week in China
May 23, 2010, 9:43 p.m. EDT · Recommend (3) · Post:
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Follow the money ... from mainland China
First Take "º
God's actual bankers behaved a lot like Lehman's
By Craig Stephen
HONG KONG (MarketWatch) -- Hong Kong can be expected to catch up with last week's steep falls in equity markets after a public holiday on Friday. It was the huge sell-off in Western markets that made headlines last week, but was a preceding fall in Shanghai's A-shares an early warning?
Analysts are now arguing that the Shanghai A-share Index is acting as a leading indicator for U.S. equity markets. United-ICAP say they have observed this since 2007, when the Shanghai market fell in advance of the Dow and also bottomed first in October 2008, while the Dow did not bottom until March 2009. This year, from its peak in April, the Shanghai market is now down 19%, while after last week's falls the Dow is down just 9%.
Asian broker CLSA Securities makes a similar point in a recent strategy note: "The negative price action since late last summer in Chinese A-shares and Hong Kong-listed Chinese property stocks looks more and more like the key lead indicator for the global risk trade."
Of course, thinking of China's stock markets as a leading indicator for global markets is quite a leap. While conventional wisdom is that equity markets are a lead indicator of economic activity, this is generally dismissed in China, where its stocks markets are considered irrational, with little correlation with the economy.
This is explained by a market that is dominated by herd-driven retail investors and where the "smart money" of foreign institutional investors is largely locked outside. A-shares are still off limits to the majority of foreign investors, and the currency is also not freely convertible.
U.S. Treasury Secretary Timothy Geithner's trip to Beijing for a meeting on the economy will be a key focus next week. On the agenda will likely be Chinese procurement rules and the Chinese currency. In Japan, traders will be watching to see whether deflation is taking hold.
This year, the economy and the stock market again appear to be heading in opposite directions. China's first-quarter gross domestic product grew at 11.9%, yet this year the Shanghai A-share market has been one of the worst performers in the world, falling 23%.
But perhaps China's stock markets are more important and rational than we give them credit for. Few would question the importance of China's giant economy -- but downplaying the importance of its equity markets may be foolish as well.
China's contribution to the recent global economic recovery is well recognized, with the state rather than consumer spending driving growth. China played a leading role with its massive stimulus and infrastructure program and state-sponsored bank lending.
Many now believe the revival in commodity prices, Asian exports and the new cycle of capex spending is down to China's stimulus. As Nomura wrote in recent strategy piece: "Investors are being betrayed by the fact this cycle commenced in China, flowed into developing markets, and then finally resuscitated growth" elsewhere.
There is also clear evidence of China's stimulus translating into equity-market movement.
An HSBC equity research note said that in November 2008, when China's government announced its 4 trillion yuan ($586 billion) stimulus program, the stock market began its recovery.
It could be China's stock markets and investors are rational, as they recognize China's economy is uniquely policy-driven. Forget GDP growth numbers (which are widely considered to be unreliable) and instead, follow policy changes.
HSBC also highlighted that this year, when the government announced an increase in bank-reserve requirements and property austerity measures, the equity market turned south on cue.
Beijing's far-reaching grip on the economy means policy pronouncements can be particularly impactful. Nomura notes for example that for H-shares (mainland Chinese incorporated shares listed in Hong Kong), they consider over 75% to be policy-driven, counting those where the government directly controls prices, in addition to banks and property that are directly impacted by tightening measures.
So the next policy move by Beijing is being carefully watched. Most still expect an interest-rate hike and for authorities to be satisfied the housing market has slowed down before easing off on tightening measures. The danger is, in a risk-adverse environment, pulling off a soft landing in the housing market has just become that much harder.
The European debt crises will also give policy makers more to think about as the sharp drop in the euro makes China's exports more costly. The consensus still appears for no change in policy until the third quarter at the earliest. Nomura suggests the situation means investors will need to be patient before there is any turnaround in administrative measures by the Chinese government.
More than ever, investors globally will be watching China's policy makers and its A-share markets. If we believe that A-shares are a lead indicator, they appear to be telling us that not only is China's growth not as strong as the numbers suggest, but that global growth too is also looking suspect. We can expect increasing discussion on whether we are now facing a double-dip recession.
With due respect to Goldman Sachs Group Inc.'s Lloyd Blankfein, CajaSur has a better claim to be God's actual bankers, with six priests on a 21-person board, writes Steve Goldstein.
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