Equinomics - View on Chinese Equities Sell Off (9 July 2015)

The selloff in Chinese equities accelerated with the Shanghai Composite Index (SCI) closing down 5.9% to 3,507 while the Hang Seng dived by 6.6% and Nikkei lost 3%. While the Indian equity market fell by 1.7%, the US markets declined 1.5% yesterday. However, the European markets have stabilized in this session, with the FTSE, CAC and DAX gaining about 0.5% each. A lot of domestic investors are worried whether this would boil down similar to what we saw in 2008-2009. Our firm view is “NÖ”: In China, the bubble was waiting to happen – first 50% rise in SCI accompanied $180 billion margin lending from the brokers. It tempted the public to open around 10 million new trading accounts which finally led to a bubble of 150% yoy jump in the index as on June 12, 2015. Metal business was so badly hit in China due to economic slowdown, still many metal stocks rose 100% during this bubble which was not sustainable; During October 2007- October 2008, the Chinese equity markets fell badly much before the global equities started crashing. Hence, some analysts “predict” that this time too similar fall in the global equities will happen. In 2008. The global equities fell due to the financial crisis in the US and the US investors were (are) the largest investors in the equity asset class across the world. They started pulling out dollars from the emerging markets – hence, almost all emerging markets crashed. It was nothing to do with the crash in the Chinese equity markets. Actually, now dichotomy between valuation of stock markets and economic growth in China is getting corrected; It is “a zero-sum game” for the Chinese people – while the Chinese economy is highly linked with the rest of the world economies, it is not the case with the Chinese stock markets. It is highly restricted. The FIIs investments in Chinese equities through portfolio investments as per the World Bank report in 2013 are around $30 billion. We don’t have such data for 2014 – but we firmly believe that it is unlikely to be any significant portion of Chinese floating stocks. Contagious effect can be strong, if the investors from the developed world lost a lot of money in one region. If that is the case, they would tend to withdraw funds from the other regions. Even after this 31% fall, the SCI is still up 75% yoy basis – so it is not true that every Chinese investor is losing in the markets. It is “a zero-sum game” for the Chinese people, certainly not for the global investors – some have lost and some have gained within China. Of course, the pain would be there in terms of wealth effect – but it all happened too fast and its impact on the global equities too would be forgotten too soon in our view; Indian markets couldn’t gain from the robust (150% yoy) rise in the Chinese stock markets – our markets rose just 3.3% yoy as of June 12 in the same period. Hardly anybody cried on the domestic market why we have failed to catch up with the Chinese markets. Since June 12th, the SCI fell 32%, but the Sensex rose 4.8% - however, the majority is “worried” that we will fall badly! What justifies this “one-way” interpretation? Almost every global institution predicts that Indian economy would grow fastest in the next 2 years, while the Chinese economy is set for a slowdown. In fact, yesterday, OECD said that India is seeing "stable growth momentum" even as economic activities are expected to slow down in China, the US and many other major economies; Yesterday’s fall in the domestic equities was due to the fear factor – our markets will continue to remain least correlated with the Chinese markets unless any major global recession sets in – which we believe unlikely at least for the next 2 to 3 years. Yesterday the international gold prices dropped 0.7% to touch 3-month low of $1147.36 and silver closed near 5-year low. Gold prices might fall further as it is a competing investment product for the equities to some extent and the Chinese were major buyer of gold till recently. Also metal prices may remain subdued, however, the Indian equities are set for a strong recovery – this is firm view of Equinomics.