A packed house attended CKGSB’s New York office recently to hear a fascinating discussion about the rollercoaster ride experienced by China’s economy in 2015, the latest event to form part of the school’s Knowledge Series.
What caused Chinese market’s roller-coaster ride?
China’s stock market surged more than 150 percent in 12 months before plunging this summer, in a wild ride that globally surprised investors. To explain the massive ups and downs to US financial sectors, Cheung Kong Graduate School of Business (CKGSB) invited elite academics and executives from AIG, Deutsche Bank and Three Mountain Capital Management to dissect the workings of the Chinese financial system and stock market in a CKGSB Knowledge Series discussion. Also examined were the outlooks for the RMB and the Chinese economy in 2016 and beyond.
A packed house at CKGSB’s New York office attended a fascinating discussion on China’s economic rollercoaster ride in 2015
The session, “Responding to China’s Financial Turbulence: a Panel Discussion,” on December 10, investigated the effectiveness of regulatory moves in China that included restricting both short selling and futures trading amid the historic tumble in the world’s second-largest equity market. The event at CKGSB’s New York office also looked at the implications of the International Monetary Fund’s decision to include the depreciating RMB next year in the IMF’s lending basket for reserve currencies, and reviewed the outlook for China’s economy, currently in the midst of a slowdown.
It was the latest in a series of in-depth examinations of hot topics in China and Asia hosted by CKGSB, its New York resident professors, and scholars from global partner organizations. The final presentation of 2015 focused on the financial turbulence because the turn of events has raised myriad questions about the current and future state of China’s economy. The panelists were CKGSB Finance Department Chair Henry Cao, Blake Zhang, Chairman of the Asian Financial Society and Vice President at Deutsche Bank Securities Asset and Wealth Management Division, Kevin Chen, Co-Founder and Chief Investment Officer of Three Mountain Capital Management, and Henry Mo, Managing Director and Deputy Chief Economist at AIG and a board member with the Chinese Finance Association.
“For the stock market to function properly, intervention is not the way to go,” Mr. Chen told the discussion moderated by CKGSB Assistant Dean Zhou Li. “What they need to do is to liberalize the market further instead of trying to curb short-selling or futures trading.”
The short-lived “bull market”
In April, a commentary in the People’s Daily, the Communist party’s flagship newspaper, declared that “4,000 [points on the Shanghai Composite index] was just the beginning” of the bull market. Two months later, shares began to dive as leveraged investors unwound bullish bets on worries that high valuations were unjustified amid slowing economic growth. By July 8, the Shanghai stock market had skidded 30 percent in three weeks.
The drop was especially punishing for thousands who lacked a diversified portfolio that could withstand the impact of a severe stock drop. Owing to the limited number of stock-investment vehicles available in China, market players were unable to acquire the same level of protection against a downturn that investors have in the mature US market, panelists said.
“Most of the investors in China were heavily investing in one sector,” Mr. Zhang said. “And then when one sector came down, they moved to another one. In terms of diversification, that’s a weakness (in the China stock investment scenario).”
Mr. Mo said the debacle showed that the government still has much to learn about operating the bourse it established to raise capital in the marketplace. “The lesson from this crisis is two things: one, to learn to respect the market,” he said. “The market has its own reason (for its behavior). Number two, the government and the authority must put investors’ best interests first and foremost.”
“Politics” drove the chairman of the China Securities Regulatory Commission to term the country’s stocks landscape as a bull market, Professor Cao said. “He wants to show that the market is going up. And also at that time I think many investors are happy, so he wants the momentum to continue.”
Panelists questioned policies that they said made it easier for investors to buy stocks with borrowed money – or to evade the rules and make even riskier bets. When investors began fleeing the market, these leveraged bets were slashed by more than $200 billion. “That amount of borrowing is unprecedented and not sustainable,” Mr. Chen said.
The deep dive
China’s stock market tumbled by more than 40 percent between mid-June and late August after enthusiastic individual investors, encouraged by State media, inflated a market bubble through large share purchases that often used borrowed money. When the rout began, the government stepped in to drive up share prices, imposing measures such as banning major shareholders from offloading shares, ordering state funds to buy stocks and restricting short selling.
Once the suspensions were lifted, the sell-off resumed. That development taught the government what Assistant Dean Zhou termed a “hard and expensive lesson” about the effectiveness of attempting to manage the sometimes wild movement of financial markets.
A discussion of the differences between the Chinese and US financial markets indicated that the existence of a high level of regulation and intervention in the operation of the Chinese bourse compared with its US counterpart helped set the stage for the market turmoil in China. Had the government allowed short-selling and futures trading activity to find their natural levels before the crash, “the market wouldn’t have this bubble to begin with,” Mr. Chen told the panel. “To improve the market, what the government needs to do is less intervention. Let the market function properly,” he said. “It will do what it does best.” Unable to see the market find its bottom, bargain-hunters had no incentive to jump in and trigger a rebound, observers said.
Professor Cao pointed out that the predominance of individual investors in the China market helped spur the skid, since many participants who used borrowed money to buy shares were inexperienced investors – and thus easily swayed by media reports to buy shares before the collapse.
Panel (from left to right): Zhou Li, Henry Cao, Blake Zhang, Henry Mo and Kevin Chen
Circuit breakers
To help calm volatility while ostensibly precluding future government intervention in market swings, China regulators plan next year to launch a system of stock-index circuit breakers. Under the system – similar to what the New York Stock Exchange did in the wake of the Oct. 19, 1987, Black Monday crash – , a 5 percent move up or down in the CSI 300 Index, a gauge of 300 stocks listed in Shanghai and Shenzhen, will trigger a 15-minute trading halt. A movement of at least 7 percent will freeze trading for the rest of the day. Circuit breakers will be triggered for trading that takes place up to 15 minutes before the markets close at 3 p.m. local time. Currently, China’s stock regulators halt individual stocks that rise or fall 10 percent during the day.
Despite the turmoil, Mr. Chen said investors in China who have the patience to wait for a major market rebound will be rewarded. Citing surging prices in Shanghai index small-capitalization and technology shares, he said: “If you are able to invest for the medium- to long-term and without taking excessive leverage, it is still a great market to be in.”
Panelists had mixed views on how the International Monetary Fund’s decision to include the RMB in its lending basket for reserve currencies would affect the Chinese currency. Effective October 2016, the IMF will include the RMB in the Special Drawing Rights basket alongside four other major currencies: the dollar, euro, the British pound and the Japanese yen.
While some panelists termed the IMF’s vote to include the RMB in the SDR basket as merely symbolic and unlikely to materially affect China’s financial outlook, Mr. Mo said it could boost overseas demand for the currency over time.
“I saw a wide range of estimates from central banks worldwide in the next few years on how much RMB they are going to purchase,” the economist said. “The number I saw ranged from $150 billion to $700 billion. I take a conservative number – that’s about $200 billion for the next few years,” he said.
If the move reduces China’s capital outflows, the IMF decision will be a helpful one for the country, Mr. Mo said. Although the Chinese currency is likely to face more devaluation pressure as its economy sputters further, he said he doubted the depreciation would be on the scale of the sharp devaluation witnessed in August.
Economic slowdown
With the event’s final section given over to answering audience questions about China’s economic outlook, the issue came up of whether China is headed for recession. Until recently, China’s economy grew rapidly, thanks to a booming manufacturing sector that imported raw materials and equipment to produce goods that were exported to North America and Europe. Slow growth in the developed world, however, crimped that trend. China’s other stimulus, infrastructure investment, has contributed to a debt load that totals 208 percent of GDP. Together, the debt overhang and excess capacity are expected to restrict future growth.
The economic deceleration – the official growth rate of 6.9 percent in the third quarter of 2015 is a six-year low – comes as the government strives to shift the country from an over-reliance on exports and investment to an economy that is more consumer-led.
“We see the manufacturing sector continuing to struggle with global overcapacity issues,” Mr. Mo said. He observed that services, including consumer spending, grew at a healthy 12 percent annual rate in the quarter from a year earlier. Although the stock market bubble and housing boom propelled that growth, which is softening now, the service sector’s share of GDP has grown while the industrial sector’s share has decreased.
Mr. Cao said that recession in China is unlikely in the short term, because the country is still developing. The current slowdown has arrived in the wake of China’s averaging about 10 percent growth annually for most of the past quarter-century.
