China Stock Markets Were Never A “Magic Pill”

Business, China, Company Strategy, Economics

By John Richardson

ChinanewstocksTHE good news is that only an estimated one in 15 Chinese people at the very most trade in stocks compared with more than half of Americans.

But the bad news is that this one in 15 is higher than it was around a year ago, when China’s stock markets first began to rally. Over the last few months alone, around 20 million new accounts have been opened on each of the country’s two exchanges – Shanghai and Shenzhen.

The further bad news is that three quarters of activity on these exchanges is in individual accounts – a much higher proportion then in Western markets, which tend to be dominated by institutional investors.

This means that if  the stock market bubble has burst, there will be a considerable number of middle class Chinese who will be an awful lot poorer than they were a couple of weeks ago.

This already includes He Wuhong, a Beijing middle school teacher and mother of a toddler. She and her husband invested nearly all of their $65,000 in savings in China’s stock market in late April and early May, only to see their account’s value fall by almost half, according to the New York Times:

And here is some even more bad news from Barron’s, the investment news service:

If the stock market keeps falling, as it did in 2007-08 when the Shanghai Composite dropped almost 70% and then remained there for six years, China’s investing public, the many corporations that have taken to speculating in the stock market on the side, and the banks that extended collateralised loans to insiders, will be in a world of hurt. This would only add to the capital destruction that impends in China’s wobbly real estate market.

But, as I said, this is still only one in 15 people in China. And as Barron’s once again wrote:

Year to date, funds raised from equity issues have totalled RMB2.8 trillion ($452 billion). That compares with loan volume of RMB52.6 trillion and RMB6.9 trillion in corporate bond issuance.

Here are two myths about China’s stock markets which you, as a result, must dismiss:

  1. That surging equities can create a new broad-based “wealth effect” to replace the end of  the credit-fuelled wealth effect of 2009-2013.
  2. That the rise in local stock markets will allow heavily indebted state-owned enterprises to recapitalise themselves, with IPOs providing a fantastic source of funding to China’s more innovative private companies.

What everyone needs to instead understand is that booming equity markets were never going to be a “magic pill” that would solve China’s economic problems.

So, even if the many government measures designed to engineer a recovery in local stock markets work, this will not change anything.

And there is in fact no single magic pill that can solve China’s economic problems.

What instead lies ahead for China is a long, hard slog of economic reforms. This will mean low single-digit GDP growth for the next few years at least.

As more and more people wake up to this reality, this can only mean an increase in global financial and oil market volatility and weakness.

This new understanding about China will combine with the realisation that EU politicians have got it completely wrong over Greece – and over the Eurozone as a whole.

Put these two events together and have the equivalent of an new Lehman Bros-type, albeit perhaps on a slower fuse.

The New Normal is well and truly here.

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