How much does China matter?

[Estimated time to read: 4.5 minutes]

Did you know last week was a record breaker?

It’s true.

You might have missed it with everything else going on in Syria, Yemen, North Korea, Saudi Arabia…

Here’s what happened.

The S&P 500 fell 4.9% – its worst four-day opening run in history.

Hong Kong’s Hang Seng index fell 6.7% – its worst start to a year since 2000 and its biggest weekly drop since March 2009 – the height of the global financial crisis.

Europe didn’t fare any better.

All the major indices suffered huge losses, with Goldman Sachs calling it the “weakest start for European indices since at least the early 1970s”.

So, with the global financial crisis barely behind us, why does the world look like it’s facing ruin again?

China of course.

As the Western world woke up to its first day of trading in 2016 – China’s Shanghai Composite Index was well on its way to recording its biggest one day fall since 10 June 2008.

Déjà Vu

Last week’s events are largely a continuation of what we saw in the second half of last year.

In short, stocks in China are falling because of a combination of four main factors:

1. Continued yuan weakness

   The currency has been falling since the Chinese government took measures last year to depreciate its value – with a view to helping its exporters. The trouble is, the government’s meddling continues to spook investors.

2. Expiration of selling restrictions

   CSRC, China’s state market regulator, had imposed a restriction on major shareholders selling their holdings following last August’s steep falls (remember “Black Monday”?).

   The expiration of this ban, due on the 8 January 2016, could have been a key trigger for the latest sell-off as investors dumped shares ahead of the expiration.

   It is estimated that RMB 100 billion worth of shares will be available for sale if the expiration is allowed to take place.

3. Economic fundamentals remain sluggish

   A survey released last week showed China’s factory activity had contracted for a tenth consecutive month in December, and at a faster pace of decline than November. Official manufacturing data, which focus on larger state-owned firms, also revealed a fifth consecutive month of contraction.

   However, a pick-up in the services sector may cushion the negative impact on the broader economy.

4. Reinforcement effect

   Once a market begins to fall, investors get spooked and sell. A vicious cycle. This was compounded by a mechanism which automatically closes the market – referred to as a circuit breaker – which is triggered by intense selling. Because people know it’s there, they try to sell before the market is forced shut.

As the second largest economy, China’s financial well being is of significant importance to the rest of the world.

An old adage used to be that “if the US sneezed, the rest of the world caught a cold”.

It is probably fair to say now that “if China yawns, the world yawns with it” – so closely is its economic data, stock markets and currency watched.

However…

While China is hugely important to the global economy, the factors which spooked global markets last week are not new.

Almost every asset manager will tell you that the long term prospects for China remain positive – it’s just going through some growing pains.

Admittedly there are other headwinds.

The price of oil is still extremely low, for example.

However, as previously discussed, the price of oil is a zero-sum game.

This view is shared by the International Monetary Fund, which believes the low price of oil and commodities generally, will in fact be a positive for the global economy in 2016.

There are other pockets of good news.

US jobs data for the last quarter of 2015 released last week “defied global pressures” – as one Financial Times headline put it. Even better, the signs are this strength will continue into this year.

This comes on top of the US Federal Reserve’s decision to increase rates for the first time in seven years just less than a month ago. This in itself is a sign of confidence in the global economy from the world’s de-facto central bank.

The UK construction and car manufacturing sectors also quietly delivered strong growth last year, spurred on by low commodity prices.

Meanwhile, things are actually quite bright in Europe.

The European Central Bank’s programme of Quantitative Easing is continuing and, unlike oil producing regions, Europe is a consumer and so cheap prices are supporting high levels of spending. Some experts even suggest the eurozone may throw up a few positive surprises this year…

The biggest danger to your wealth

So what’s the biggest danger to the global economy and your money? As the world saw so painfully in 2008, it’s confidence.

If confidence in stock markets deteriorates then, yes, there is the potential for 2016 to be a most unhappy year for investors. Particularly for traders and those looking for, or betting on, a quick win.

However, any regular reader of this blog will know that’s not the game we play.

It can be very hard to keep one’s nerve when everyone around you is losing theirs, but that’s what you may need to do this year.

If you are a long term investor in equities – this year may feel painful.

However, long term, any investments you make now – or in the coming months or weeks – could be some of the most valuable you make.

The biggest danger to your wealth then, bigger than China, bigger than a collapse in the oil price or a recession in the US, is YOU.

If you make rash or knee-jerk decisions this year, you could regret it for the rest of your life. Be confident in the international investments you make and don’t let fear throw you off course.

If you want to know more about how to avoid the pitfalls of investing, contact us by clicking below.