Chinese Stocks: The New Unknown

There are two forces driving Chinese stocks:

 

  • The PBoC is among the few major central banks that can engage in further monetary easing, and China’s ongoing fiscal stimulus programs will likely shift into high gear in the coming months. This, together with a stable household sector and service industries, should preclude major growth disappointments.
  • But investors are no longer just worried about the growth slowdown. Even though the flash manufacturing PMI last week may have contributed to the selloff in Chinese shares, the growth slowdown is not new news, and should not have caused such dramatic market reactions. The new unknown is the Chinese authorities’ willingness and ability to keep things “under control”. Notoriously poor policy transparency has further worried investors, leaving fear and anxiety dominating sentiment. As a result, anything China related is aggressively liquidated.

Our China strategists expect that the growth outlook will eventually matter for stock prices from a cyclical point of view, but it will be an uphill battle for the Chinese authorities to regain credibility. Until then, the risk premium attached to Chinese equities will stay elevated.

Global Deflation Trends To Intensify?

Understanding Chinese policymakers’ motives is tricky and can be contentious. Leaving aside whether the motivations behind the move to make the exchange rate responsive to market movements were economic or political, what is clear is that the risks are on the side of more deflation for the global economy.

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Our EM strategists have expected for some time that the Chinese RMB would depreciate around 7-8% this year, while our China-focused strategists have argued that any depreciation would be more benign, because Chinese policymakers have a strong interest in maintaining a stable exchange rate and to avoid being labeled a “currency manipulator”.

Investors should not ignore the irony that today, the PBoC intervened to stabilize the currency after only one day of allowing the market “to play a greater role in determining the currency”. This suggests that it is unlikely that the PBoC will completely give up control and allow the official rate to drift along with spot market rates.

Regardless, the balance of forces were already tipped toward more global deflation. A weaker RMB would only serve to further undermine Emerging Asian currencies, which means that China along with the whole of manufacturing Asia, will potentially further cut export prices in U.S. dollar terms. That would continue to suppress inflation in the rest of the world in general and the U.S. in particular. U.S. import prices from Asia are already deflating.

As for the Chinese economy, one major problem remains the overhang of credit, please see the next Insight, China: Credit Impulse Versus Government Spending.