While Chinese equities are undergoing a sharp correction, and the volatility could last for some time, policymakers have both the tools and the resolve to support the broader Chinese economy, according to AllianceBernstein (AB).
“The sheer scope and speed of the sell-off has left investors around the world understandably anxious,” says Stuart Rae – Chief Investment Officer, Asia-Pacific ex Japan Value Equities, who, with two colleagues, is co-author of a forthcoming AB research white paper on China.
“But there are still important areas of stability in China’s capital markets, and we believe that policymakers have the willingness, the desire and the ability to support the economy.”
China’s A shares market – local currency-priced shares of companies incorporated in mainland China and traded only in mainland equity markets – was the centre of this week’s sell-off. By close of business yesterday, the Shanghai Stock Exchange Composite Index had fallen nearly 30 per cent from its June 12 peak of 5,166.
The government has implemented a number of measures to support the market – some of them quite aggressive. For example, authorities have allowed about 1,400 firms, representing nearly 50 per cent of the market, to suspend trading of their shares. That’s causing a liquidity crunch in the market for A shares.
Hayden Briscoe (pictured), Director – Asia-Pacific Fixed Income, pointed out that, in striking contrast to the anxiety affecting equities, China’s government bond market has performed much like those in mature, developed-country economies during periods of “risk-off.”
“It’s provided a buffer against share market volatility and a safe haven for investors. During the second quarter, Chinese government bond prices rallied, with yields on two-year bonds falling 75 basis points, from 3.25 per cent to 2.50 per cent,” saisaysd Briscoe.
“This relative stability in bonds, in our view, partly reflects improvement in China’s economic fundamentals. It’s also an indication of the government’s success in balancing the need for deleveraging and financial and economic reform with that of supporting the economy to maintain social stability.”
Briscoe also noted that volatility remained under control in other parts of the financial markets, too. Yields on bonds issued by China’s policy banks – China Development Bank, Agricultural Development Bank of China and the Export-Import Bank of China – have tracked those on government bonds, with the spread between the two markets remaining relatively stable.
“The short-term money market does not appear to be showing signs of a large liquidity squeeze, with the onshore seven-day repurchase rate holding at around 2.50 per cent after rallying from above 4.00 per cent in the first quarter – a reflection that lower policy rates by the People’s Bank of China are working.
“In the currency market, both the offshore (CNH) and the onshore (CNY) have been stable. Over the last month, CNH and CNY performance has been essentially flat relative to the US dollar, indicating that policymakers want to keep the currency at current levels,” says Briscoe.
Rae added that the contrast between equity and bond market performance is also a reminder that, in China, it usually pays to look at the big picture – including economic and policy trends – when assessing market risks and opportunities.
This is because government policy still plays an important direct role in China’s markets and economy, even as the country moves toward a more open, Western-style economic model.
“While economic headlines remain patchy, it is worth noting that policy stimulus and monetary loosening are starting to have a positive impact,” says Rae. “The manufacturing Purchasing Managers’ Index (PMI) has started to edge higher, and the all-important residential-property sales are showing signs of recoveries in most of China’s larger cities. Corporate earnings for 2015, after a series of downward revisions, may start to edge up again in response to the macro picture.
Policymakers have shown both the willingness and the desire to support the economy, as seen in reductions earlier this month to interest rates and banks’ reserve-ratio requirements, said Rae.
“It’s worth noting, too, that the sell-off in equities was not triggered by any fundamental developments, but by a market reaction to government measures to cool excessive margin lending in the stock market. That same margin leverage, in turn, exacerbated the correction and resulted in very high market volatility.
“Of course, with the balance of margin loans still at a very high level, A-share market volatility may last for some time yet. So, too, will the government’s attempts to contain it. This means that the outcome of the current period of uncertainty will depend to a large extent on how the government responds.”
Anthony Chan, Asian Sovereign Strategist – Global Fixed Income Research, pointed out that AB’s base case view on how successfully China would implement its reform program and fulfil its potential as an economic and financial powerhouse has always hinged on its assessment of the government’s determination and ability to stick to its policy objectives.
“This is the big test in the short term: whether – and how – the government will resolve the stock-market correction and prevent an economic reversal.
“It’s possible that a more sustained sell off could spread to other markets within China and beyond, which could weigh on the economy. But in our view, the government isn’t running out of policy options – though don’t look for it to follow the US, Europe and Japan down the path of quantitative easing.
“The key question is what Beijing will do if a genuine financial crisis develops and the economy looks headed for a hard landing. Will it abandon its reforms and revert to all-out fiscal and monetary reflation?
“If it were to come to that, we believe China’s massive liquidity resources will be sufficient to the task. While this would be disappointing for those keen to see China reform and put itself on a sustainable path of growth, it should at least bring comfort to investors who have difficulty seeing beyond the equity market’s gyrations,” says Chan.
The research white paper, Future Shock: How China’s Reforms Are Creating Disruptive Risks (and Opportunities) by Rae, Briscoe and Chan will be publicly released later this month.