FYI | Jun 05 2007
By Greg Peel
In February, an 8.8% fall in the Shanghai Composite Index sent global equity markets into a tail spin. It came out of the blue, and initially was not even appreciated. Australia, which shares a good deal of the Chinese time zone, traded blissfully upward on that fateful day in February, oblivious to the fact that China would send the US into a panic that night. Only the next day did Australia respond.
Last week, the Shanghai Composite fell 6% before the Australian close, and the ASX 200 had a 70-odd point pullback. The market had already opened weak ahead of the Chinese opening, so it’s hard to say that China fears were a significant driver. If the reaction were equivalent to February, then the ASX 200 may have been down over 100 points.
Since February, brokers and traders around the world have added Shanghai to their alert screens. No one wants to be caught out again, and the situation has only become more perilous since the Chinese market has not only recovered, but surged ahead once more on the back of a new investor-led frenzy from the average Chinese working man and woman. The warning bells were sounded from New York to London to Sydney – the Chinese market was due for a correction.
Thus when the Chinese government increased the local stamp duty rate from 0.1% to 0.3% last week, fears were roused that this might be the trigger. The last stamp duty increase ushered in a bear market in China that lasted from 1997 to 1999. At that stage the duty was 0.5%. It was gradually lowered in steps back to 0.1% in 2005, following another bear market that had lasted from 2001. Last week’s was the first hike since. It is clear that the Chinese are not big on taxes.
But back in 1999, no one paid any attention. China was not part of the global financial landscape. That’s why the 9% fall in February came as a surprise to many who’d previously paid little heed to a small, immature localised stock market. But it was what the Chinese fall represented in February that was more significant than the fall itself. It meant that risk premiums in emerging markets may just be a little too low. And for that matter, risk premiums in just about anything may be a little to low. Thus followed the US sub-prime mortgage scare and a brief but panicky unwinding of a lot of hedge fund positions in the yen carry trade. And a subsequent correction in global equity markets.
When the Chinese market fell 6% last week, Australia was weak, and Europe was weak, and both were waiting to see just how badly a potentially overblown US market might react. Then the Dow rallied 100 points.
The Dow had opened lower, but economic data on the day was positive and quite simply – the US is in an almost transcendental state of exuberance at the moment. All good news is great news and all bad news might actually be good anyway. Wall Street is on financial ecstacy.
The Dow opened lower last night as well – about 50 points – but recovered to square up on the day. No real reason was given for the recovery other than a generally positive feeling, and perhaps the realisation that a stamp duty increase in China is a very localised, fiscal development and has no reason to resonate across the globe. Business as usual. Having sold last week only to see the Dow rally strongly the next day, Australian investors largely ignored the slipping Chinese market yesterday, which was down a good 6% by the local close. Europe slipped only mildly.
Does this mean we have nothing to fear about the Chinese equity market anymore? Was it all just a silly overreaction in February? A quick look at a one-year chart on the Shanghai Composite is sobering. The 52-week range is 1541-4336 – a 181% rally and virtually all of it simply up. The February correction is barely noticeable on the one-year chart. Realistically, the Chinese market could fall an awfully long way before anyone could consider it more than just a healthy correction. It would not herald the collapse of the Chinese economy and a subsequent collapse of commodity prices. In fact, if the Chinese market did correct then global investors may just feel comforted that a more lethal blow-off top, representing a Chinese implosion, was no longer to be considered a spectre hanging over future performance.
Maybe a fall in the Chinese stock market is actually a good thing. As long is it’s measured and steady and not too disturbing. A 50% fall on the day might be a different story.