It’s all China’s fault. Or is it?
It’s easy to blame most of what’s wrong in the world of investing – stock markets posting their worst start to a year in history, economies around the world slowing, commodity prices hitting all-time lows – on China.
“The state of the Chinese economy, which Beijing says decelerated to 6.9 percent growth last year, and whether the yuan will collapse have become a worry for global investors, who have counted on China as a source of growth for more than a decade,” complained the Wall Street Journal yesterday.
We think that China’s growth is slowing sharply, and that the government’s growth targets make the problem worse. It’s likely that the yuan will decline in value. The country’s pollution problem could become something even worse.
But what if markets and conventional wisdom are wrong? When a lot of people are saying the same thing, it pays to avoid the bandwagon effect and look at the other side. Here we look at how things could be sunnier in China than most people think.
China’s stock market doesn’t really matter. China’s stock market has little to do with the underlying economy. Unlike most markets, China’s stock market isn’t a leading indicator of economic health. So the 43% decline in the Shanghai market, and the 41% drop in the Shenzhen market, since 2015 highs says very little about what’s really happening in China.
Around 85% of China’s stock market trading volume is from small individual investors, the vast majority of whom are speculators who view stocks as ticker symbols in a casino, rather than companies to invest in. According to the China Household Finance Survey, two-thirds of these investors don’t even have a high school education. This makes China’s stock markets driven by emotion, rather than fundamentals, and even more likely to rise and fall sharply and abruptly.
Also, China’s stock markets finance just 2% of fixed asset investment. Only 1% of company loans have shares as collateral. Chinese banks don’t have big stock positions. So a drop in the stock market doesn’t reflect anything that’s wrong with China’s real economy, and it doesn’t hurt the country’s economy.
The yuan’s fall is smaller than you’d think. The amount of concern over the decline in China’s currency is inversely proportional (that is, opposite to) how far it’s actually fallen. Since the beginning of the year, the yuan has declined 1.3% against the dollar. Since August 1 – before the market began to focus on China’s currency – it’s fallen only 5.7% against the dollar. This is not the first time the yuan has fallen against the U.S. dollar – and it’s not even one of the worst declines.
And that’s after years of real appreciation of the yuan relative to other currencies. So the recent decline isn’t as bad as it might seem to be, if you only listened to the howls of concern from the financial media.
China’s service sector is growing strongly. Gloomy financial reports from China revolve around the industrial sectors, especially construction. These are hurting demand, and prices, for steel, cement and real estate, which in turn has hurt commodity prices.
But China’s service economy – which includes financial services, retail, health, education and IT – is growing fast enough to make up for the slowdown in the industrial sectors of the economy. It’s difficult to measure, but a lot of signs point to growth that might not be reflected in economic figures.
For example, passenger rail traffic in China is up by 10% over the past year. In 2015, Internet traffic through mobile devices doubled, movie ticket sales were up by 50%, and Starbucks opened 1.5 stores a day in China. Luxury goods retailer Coach posted double-digit growth, and athletic goods maker Nike saw sales in China rise by 30%. Electricity consumption often slows as an economy decelerates, but electricity consumption in China hasn’t seen a slowdown.
China’s middle class is booming. By one measure, China’s economy is the biggest in the world. China’s middle class is the largest in the world. China is now home to over one million millionaires, and gets a new billionaire every week. And there are more poor people (people in the bottom 10% of net wealth globally) in North America than in China (where there are almost none at all). And that’s even though China has four times the population of North America.
Markets overcorrect – both ways. When people begin to think a market is in trouble, they tend to focus more on the negative than reality suggests makes sense. Is this happening with China? In some ways, China might be healthier than a lot of people think. That doesn’t mean China’s economy isn’t slowing, or that China’s stock markets won’t continue to be weak. But it might mean that at a certain point, investors are more downbeat than the facts warrant.