The China Syndrome
As we enter the fourth trading day of 2016, world stock markets seem to have a bad case of nerves. As you know, we don’t believe that what happens in the markets on a day-to-day or month-to-month basis carries any real information, dominated as it is by the “noise” of the daily news cycle (see Weekend Chart Challenge for a graphical demonstration). Nonetheless, the predictably dramatic headlines prompt us to share a few thoughts.
Much of the market turmoil of these first few days of the new year is being attributed to new doubts about sustained growth in the Chinese economy, which has come to represent a sizable share of global economic activity. From the raw materials it buys from Brazil, to the manufacturing equipment imported from Germany and the U.S., Chinese demand is viewed as a bellwether for global economic growth. And all signs point to a slowdown. Of course, “slowdown” is a relative concept, with China’s economy predicted to grow by 6.9% in the coming year, a rate that is the envy of more mature economies in the U.S., Europe, and Japan. The real issue, from our perspective, is the question of how much China can manipulate or control economic growth in general and the stock market, in particular. So, two observations and a conclusion:
1.) In recent years, China tried to stimulate growth by over-investing in infrastructure, with high-speed trains to nowhere and block after block of empty office and apartment buildings. When a country over-invests in infrastructure, they add less and less to future economic growth (the U.S., by comparison, is grossly under-invested in infrastructure and, for us, these would be high-return investments). We’ve been writing about this for the past five years and believe that it will ultimately be a healthy development when China’s economy is driven more by the legitimate demand of its citizens and trade partners. However, transitions can sometimes be a little unsettling in the short run.
2.) We are also seeing a test of whether the Chinese government can control its stock market. It attempted to do so last August, during another period of falling prices. Back then, the government encouraged Chinese companies to increase their share purchases in order to drive up demand and, thus, prices. Such manipulations are at odds with the real purpose of markets, which are big information processing mechanisms that should be setting prices based on emerging trends in the economy, not artificially created demand. If markets are big enough, they’ll foil such attempts at short-term manipulation and this was the case in China, last August and now.
All of which points to the potential for the Chinese economy and stock market to emerge from this period of volatility looking more “normal” and mature and less like something that can be manipulated at will by the government. However, like many such transitions, this one will create uncertainty and a lot more “noise” for world markets to digest. We believe that the transition will ultimately be healthy for both China and the world economy and that the present bad case of nerves rippling through global stock markets will, inevitably, pass.
Happy New Year!