27th July 2015
Anthony Rayner, co-manager of Miton’s multi-asset fund range, compares Chinese and Western responses to crises in equity markets…
The Chinese equity market started to rally last year, in anticipation of easier fiscal and monetary policy, as the authorities signalled their desire to boost growth. Irrational exuberance quickly spread and Chinese investors, initially encouraged by the authorities, pushed the market sharply higher.
This year, policy makers started to become concerned over the leverage building up in the market and they intervened, bringing the market lower. Currently their focus is on reducing the excesses, whilst ensuring that systemic risks do not rise.
Much of the Western press is keen to emphasise the absurdity of these events and how well they illustrate the naivety of the Chinese government. So, to start off on a more objective footing, it might be helpful to recognise some of the similarities to the Western model.
Indeed, while the scale of the excesses and the degree of intervention are different (for example denying shareholders the right to sell shares), the philosophy of intervention in financial markets has been well-honed in developed economies.
Many choose to overlook that official interest rates have been manipulated for years by Western central banks, rather than set by the market, and that their use has led to numerous asset price bubbles, including housing, TMT and bonds. Even central bank action post the Great Financial Crisis (GFC), which has more explicitly manipulated financial markets, seems to be ignored when pouring scorn on the Chinese authorities.
Intervention by the authorities globally has defined markets since the GFC, and this includes China. Just as European Central Bank (ECB) head, Mario Draghi declared he would “do whatever it takes”, so the Chinese authorities have made it clear that they are ready to intervene if systemic risks rise. In addition, well-flagged policy action in developed economies has been leading to investors herding into crowded trades and leading to less stable markets. This also has clear parallels with China.
There are, of course, many differences to highlight as well. For example, that the Chinese authorities have more capacity to intervene, this compares starkly with the ECB, where their structure often leads to a slower, more measured response. Many also assume that such stockmarket falls would necessarily have a serious negative wealth effect on the broader economy but this is also a lazy assumption. Unlike the US and the UK, equities are not a large component of wealth in China and the economy is still very much led by investment, rather than consumption.
Going forward, it seems pretty clear that the authorities will intervene if they believe further deleveraging is leading to materially higher systemic or regional market risk. There remain questions around the second order impact on the Chinese and regional economies, and the global economy, through trade and financial linkages. Part of the answer will lie in how the Chinese stockmarket pans out in the second half of the year, but more generally we feel visibility is poor.
As far as our portfolios are concerned, we have minimal direct exposure to Asia ex Japan, due to an unfavourable risk reward profile, or to commodities, which we feel will continue to struggle in an environment of higher US rates and a stronger US Dollar, never mind a Chinese economy that might well be slowing. Elsewhere, we continue to keep an eye on second order effects, such as auto exports to China, as we have a number of exposures to auto related companies.