There is little doubt that 2016 is likely to be another year of volatility in China. This is down to continued government intervention in its A-share market, while the manufacturing and construction part of the economy is set to grow more slowly.
Privately owned firms will take more market share from state companies, and as the government presses ahead with structural reform in the state sector, capacity reduction will add to volatility.
This volatility can, however, create opportunities for investors, especially when dire headlines incorrectly assume that weak performance by outdated market indices signal an economic hard landing. And keep in mind that volatility due to the execution of necessary reforms, such as reducing the role of state-owned enterprises, is good for the long run.
The early January sell-off was probably due in large part to the very high share of market turnover (more than 80 per cent) from small retail investors and the impending expiration of a six-month ban on selling by major shareholders, which was imposed by China’s securities regulator.
Another factor was that a new ‘circuit breaker’ for the market was poorly designed, fuelling investor anxiety about liquidity as the index declined. Regulators later suspended the use of this new measure, which was contributing to, rather than reducing, volatility, and the temporary selling ban was extended. The next round of selling was probably triggered by exchange rate concerns.
The Shanghai Composite index ended 2015 down 31 per cent from its June 12 peak but up 9 per cent for the full year, making it one of the world’s best-performing markets for 2015.
Within a few days, the index was down 2 per cent year on year. The index is heavily weighted towards state-owned firms rather than the privately owned companies that employ more than 80 per cent of the workforce. The index is also focused on the old economy, rather than on services and consumption – the biggest part of the economy – and as a result, dramatic fluctuations do not reflect what is happening in the broader Chinese economy.
This is why very few Chinese invest in the A-share market, and foreigners hold less than 2 per cent of the market capitalisation. Most foreign exposure to China comes via mainland companies listed in Hong Kong, a market which is less volatile, as well as less expensive.
China’s GDP rose by 6.9 per cent in 2015, and it is inevitable that most economic statistics, including GDP, will continue to grow at gradually slower year-on-year rates for many years to come. This is due in part to structural changes, including a shrinking workforce, and because after three decades of 10 per cent growth, the base has become too big to sustain double-digit expansion.
However, because of the bigger base, the incremental increase in the size of China’s economy this year, at what is likely to be 6-6.5 per cent, will be significantly larger than the increase a decade ago at a faster rate. This means 2016 will provide, at the slower growth rate, a bigger opportunity for firms selling goods and services in China.
Moreover, GDP growth may be the least important statistic in China. After all, investment decisions in the US or Europe are not based on GDP growth rates. The important statistics in China concern employment, income, inflation and consumer spending. All of these data points should be healthy in 2016.
Unemployment is expected to remain manageable and wage growth to be strong, leading to a very healthy consumer and services sector, which is now the largest part of the economy.
The government appears comfortable with the fact that growth is decelerating, and, in my view, will only intervene to ensure the slowdown is gradual.
Two stimulative policies that will probably be maintained are cutting interest rates and taxes. At 4.35 per cent, the benchmark one-year lending rate is still relatively high. Cuts will be great for Chinese homeowners, and will reduce financing costs for the largest group of corporate borrowers – the small, privately owned firms.
The key thing to recognise is that Chinese equity markets do not reflect the health of the Chinese economy, and not to panic when there is market volatility. Short-term volatility is manageable with a long-term investment horizon, especially if we believe China’s economic policymakers are pragmatic and heading in the right direction.
Andy Rothman is investment strategist at Matthews Asia
