In the summer of 2015, the Chinese authorities overdid their enthusiasm for wider share ownership. With their general encouragement, brokers advanced large sums to individuals to buy shares. A buying frenzy developed in the markets and the Shanghai index hit a new high of 5,166 in June. The government decided things were getting out of hand, with excess credit and dangerous levels of risky loans, and changed tack. The market fell sharply. The authorities were left struggling to break the falls and to re-establish control and some order. It set back financial reform a bit, and led to some domestic share buyers being badly damaged by the experience.
Today, the Shanghai Index sits at 2,561, just half the level of the peak three years ago. After a deep fall there was a good rally, but the market has slipped back badly again in 2018. This year the market has been damaged by the external news with President Trump pursuing his campaign to get China to reform the way she manages technology, inward investment and trade. It has also suffered from the decision of the authorities to clean up the shadow financial sector, where they judge there to be too many bad loans and excess credit. Despite some efforts to relax money policy a bit by allowing the banks to lend more relative to their capital and cash holdings, the overall impact of the new policy has been slower money growth and greater caution over new advances.
The Governor of the People’s Bank of China has recently given a sensible and reassuring review of what China is trying to do. One of the most interesting features of his October address to an International Monetary Fund committee was the way he sought to meet the criticisms of the US without mentioning them by name. He explains that he is seeking to make it easier for foreign financial firms to enter the Chinese market, relaxing the caps on how large a shareholding in a new Chinese venture they can hold. He explains that policy is designed to avoid competitive devaluation, though he also wishes to see the markets playing a larger role in valuing the currency. He announces that China’s balance of trade surplus has narrowed by 33% so far this year, with a much larger increase in imports than in exports. The understated message to President Trump is that China will open her markets more to US companies, will import more from the US and elsewhere, and is not a currency manipulator trying to rig markets in favour of their exports.
To the US, the Chinese surplus remains too large. The US agenda includes wanting protection for US Intellectual property, better terms for US investors into China, and an explanation of how the Chinese currency has nonetheless fallen this year. Whilst President Trump is not likely to welcome exchange intervention to drive the currency down, and will be pleased there is some movement on controls on investment in China, he will not regard this as enough. Whilst many US investment professionals have disagreements with their President, they probably share his negative view of Chinese business tactics, and have been willing to pull money out of China this year to invest it more successfully somewhere else.
Meanwhile The Chinese authorities wrestle with their own bigger domestic issues. The Central Bank says it plans to keep markets liquid whilst at the same time regulating financial organisations more firmly and ordering the run off of excess credit and bad debts. As they say, they have a dual pillar policy based on monetary policy and macro prudential policy. They have “significantly enhanced” regulation of wealth management, shadow banking and internet finance in ways which clearly slow credit growth. They will be aware that President Xi reaffirms his overall goal of China reaching the status of a “moderately prosperous society” by 2012, which would not welcome a recession or financial collapse.
China has been word perfect in what it has been saying about the international trading order and the need for a prudent but expansion-minded policy. They have not responded too hotly to President Trump’s insistent demands of fairer trade and better Chinese market opening. The problem for investors is there is no immediate trade resolution between the two largest economies of the world in sight, whilst Chinese growth is slowing a bit. The effort to balance money policy needs between cleaning up past excesses and ensuring enough new credit to promote growth is proving tough. That is why we have now had a bear market on and off for more than two years, and it explains why the Shanghai Index has halved. It means there may be more value now in Chinese shares. The trigger to become more bullish could be a more decisive move by the Chinese authorities to increase money and credit growth, moves to settle with the US on trade or narrower measures to rekindle enthusiasm for share ownership in the large domestic market.
The above article was previously published by Charles Stanley on 18th October 2018