China: A Time Of Troubles?
Is China entering a time of troubles? Yesterday’s 0.27% interest rate cut – the first in six years – and today’s 4.5% fall in the Shanghai Composite Index to a 20-month low of 1,987 may suggest so. The stock market is now down 68% from its peak in October 2007, and I do not preclude it falling even lower. In fact, I first mentioned in Business Monitor Online in June this year that the equity index could fall to 1,800. That level is now in sight, and I can see scope for a further fall to 1,200, which would represent a colossal 80% drop from its peak. Hopes for government intervention to revive the market have proved naïve.
Shanghai Composite Index
It is clear to me that the Chinese authorities are now very worried about economic growth tapering off. For much of the past 4½ years, their priority has been to cool growth to more sustainable levels, hence a total of 216 basis points of interest rate hikes (to 7.47%), countless increases in reserve requirements, credit curbs on key economic sectors, and a guided acceleration in the appreciation of the Chinese yuan. However, the yuan’s appreciation – once completely taken for granted – has virtually ground to a halt these past 2½ months, and in fact, August saw the second-ever month that the yuan depreciated against the dollar since its 2.1% revaluation in July 2005. If the global economy tanks, then China will not allow much more yuan appreciation this year, especially since other Asian currencies are plummeting (thus giving China’s exporting rivals greater competitiveness).
Monthly Chinese Yuan Appreciation (%)
Slower Chinese and global economic growth will prevent the Shanghai stock market from recovering quickly. I foresee two scenarios for Chinese stocks over the coming years, based on the experience of Taiwan’s Taiex and Japan’s Nikkei 225 index. Both experienced a super-bubble in the late 1980s, and both subsequently saw a sharp collapse. In the case of Taiwan, it took 10 years for the market to climb even close to the 1980s peak, which has still not been exceeded. In the case of Japan, the equity market trended lower over the subsequent ‘lost decade’, and is unlikely ever to reclaim its past glory. Given that Japan was already a mature economy at the height of its equity boom, whereas China is still very much an up-and-coming economy, I suspect that the Shanghai stock market will follow the Taiwanese trajectory. It is difficult to be bearish towards Chinese stocks over the long term, given China’s great potential. Still, a return to 6,000 is probably years away, and any repeat of the surge in 2006-07 would probably be treated with caution by investors.
Taiex And Nikkei Indices