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What does the stock market rout tell us about the Chinese economy?

September 9, 2015 / By  

In mid-August, China’s domestic stock market resumed a steep decline and caused widespread concern about the health of China’s economy. However, a crash in Chinese stocks does not tell us much about the real economic conditions in China. The limited amount of institutional investment and the absence of international investment mean that it is driven mostly by amateur investors. Furthermore, the average company in China does not depend on the local stock market for financing. The average individual does not depend on the market as an investment tool, with only a tiny fraction of personal wealth in stocks, as compared to bank deposits and property.

A rising stock market was desirable to increase equity financing opportunities for companies. The Stock Connect scheme and interest rate cuts laid a solid foundation, but a speculative component quickly took over. It did not take long for P/E ratios to become unrealistically high. Individuals invested with confidence in the belief that the bull market had the backing of government. However, official efforts to rein in margin financing raised questions about the level of government support behind the market, leading to sell-offs.

There have been no significant economic data announcements recently, other than the export drop, which by itself is not unusual or particularly new. In fact, economic data is mixed, just as it has been for quite some time. Overseas equity investors saw a market going down in China, and a knee-jerk reaction took place, leading to sell-offs.

An important catalyst in the global sell-off was that the devaluation of the yuan was widely misunderstood. There was confused messaging about the central bank’s goals. Overseas markets saw it as a reflection of poor economic performance. However, the devaluation was part of an ongoing exchange rate liberalisation as China slowly moves away from a fixed rate regime one step at a time.

Meanwhile, the recent cuts to the benchmark interest rate and the reserve requirement ratio are useful tools to boost the real economy. The main motivation is to boost not only confidence in the economy, but to trigger a real growth response to reassure the world that the country is still on strong economic footing.

The direct effects on the property market are relatively limited. China is moving towards a consumption-based economy and recent events do not change this. During the stock market boom, there was no corresponding boost in retail sales or consumption. Similarly, we cannot expect a negative effect on retail sales on the way down. In the office sector, we note that wealth management firms and small financial companies with stock market exposure account for only a tiny share of occupied space in Tier I markets. However, demand fundamentals in Tier II and Tier III cities will face the same challenges as before the stock market crash. For institutional investors in property, China’s Tier I cities still represent an opportunity to gain exposure to a market with deep and wide occupier demand.

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