China’s economy did not collapse, the country’s stock market is fine — in spite of the hype.
“I keep telling my mother that she needs to make more diverse investments. She only wants to buy houses. She says that the stock market is only a place to lose money,” Cody Chao, a medical student in Suzhou, exclaimed at the end of May.
At that time China’s stock market was booming, chugging rapidly upwards on a bull run that saw the country’s two stock indexes more than double their value, new investors were flooding into the market, and everybody seemed to have been making money.
The medical student from Suzhou was aggravated that his parents rigidly maintained the conventional Chinese sentiment towards the stock market: it’s too inconsistent, too opaque, too corrupt, too good of a way to lose money. In the words of Damien Ma, the coauthor of In Line Behind a Billion People, “. . . many Chinese think [the stock market] is almost like a casino and detached from economic fundamentals.”
After several misaligned attempts to use the banking system to deploy capital, the Chinese government tried something new: it would use the stock market. Some big, struggling state owned enterprises would go public, the people of China would put their money into them, and everyone high, low, and in the middle would prosper. It was a fund raising attempt, a big transition towards stimulating the economy through markets rather than the usual course of outright fiat or urbanization.
For a moment it appeared as if times had changed, as if the Communist Party’s plan to loosen its grip on the economy a little more was leading to fruitful ends. The government and its media mouthpieces talked up investing in the stock market, encouraging the rabble to jump in. Masses of traders were lured over to the gaming tables and kept turning up winning hands. Rumors, “xiaodao xiaoxi,” drove the stakes higher, pulling in more and more new investors from more diverse sects of the population — two thirds of which didn’t even have high school diplomas — who anted up on the chance that they could take a cut of their country’s corporate spoils.
“Beijing wanted to engineer a bull market just short of a bubble,” Damien Ma stated. “It was hoping to use the stock market as one way to do equity financing for many of the SOEs and help alleviate debt. It also thought households were having a harder time investing in property, so this was another channel for investment.”
Although what actually happened perhaps even the Communist Party couldn’t have predicted: more than 30 million new stock trading accounts were opened in the first five months of 2015 — nearly one for every person in Canada. The Shanghai composite shot up over 150pc, which was paralleled by the booming Shenzhen composite, bringing the total value of China’s stock market up to over $10 trillion for the first time ever. Suddenly, it became clear than a familiar mainstay of the Chinese economy had again arisen: a bubble.
“Fundamentally, the stock had risen too far, too fast, trading at unrealistic P/E ratios, particularly when the economy was slowing,” explained Mark Tanner from China Skinny, a Shanghai based marketing, online, and research agency.
Paradoxically, one of China’s biggest economic challenges often results from its own success. This is a country with a population that has a massive amount of ready to invest cash. So any area of the economy that becomes “hot” tends to result in a massive influx of rapid investment, which often pushes it beyond the brim of stability.
“The Chinese have the highest savings rate in the world,” explained Harry Wu, a Chinese financial adviser, “which means they have cash on hand, and are looking for investment opportunities instead of bank deposits.”
China doesn’t lack individual wealth, it lacks viable options of where to put it. There are just not enough streams available to the public to divert the deluge of capital they have built up.
“The bottom line here is that China’s immature financial market simply does not have a diversity of investible products for households,” said Damien Ma. “But you can’t really solve that problem simply by pushing people to get into the stock market.”
The stock market bubble burst on June 12th, as a good chunk of the gains from the bull run were quickly lost. The Shanghai composite dropped 30% and Shenzhen did not fare much better. Over $3 trillion of the market’s value was estimated to have been lost throughout the downturn, as the feeding frenzy quickly turned into a puke fest, with masses of traders trying to regurgitate their pungent investments and mitigate their loses as much as possible. The central government stepped in with hundreds of billions of dollars to keep the market afloat, but a good measure of recently gained investor confidence had been lost.
By this time Cody Chao and his mother were sitting in a hotel lobby in far away Melbourne. The television was blaring headlines about the stock market crash that had taken place back home, prompting his mother to turn to him and chirp, “Told ya.” The conventional Chinese take on the stock market had validated itself yet again.
For all the noise in the international media about China’s stock crisis remarkable little of this volatility can be observed on the ground. At one point the Shanghai composite dropped 8% in one day but Shanghai itself remained unfazed. Stores were still open, people were still shopping, public services and institutions were still up and running, nobody was rioting, everyone was going to work as though their country was free from any type of economic crisis.
So to what degree does activity in the stock market affect the rest of the Chinese economy?
“The answer, surprisingly, is not as much as you might expect,” said Steven McCord, JLL’s head of research for north China. “Honestly, the biggest direct fallout I’ve seen so far hasn’t gone beyond some jittery discussion among stock-playing colleagues, blaring newspaper headlines, and concerned emails from clients outside of China.”
“To be honest, while I’ve been reading about the free fall, the circles I’m exposed to here in Shanghai and across central China appear to have been relatively unaffected,” said Thomas Dunlap, the regional account manager of central China for Navitas.
Action in the stock market in China is not directly indicative of what happens in other parts of the country’s economy, and vice versa. At the height of the equities bull run, year on year rise retail sales had slumped to their lowest level in five years, “indicating how disconnected stocks and retail spending are,” Mark Tanner explained. While conversely, with the stock market downturn still in full swing, consumer confidence was on the rise, according to Westpac. Likewise, as the stock market was starting to soar in March China’s exports plunged a dramatic 15pc, before rebounding a few months later in the face of plummeting stocks. Throughout all of this, China’s banking sector was shored up solid, GDP remained flat at 7%, and the real estate market remained relatively unaffected. At least in the short term, China’s stock market seems to exist within the buffers of its own reality, kept at arm’s length from the other sectors of China’s financial matrix — from what is sometimes referred to as the “real economy.”
“Given the size of the drop, the damage has been surprisingly contained,” stated Steven McCord.
One of the reasons for this is the surprising limited role that the stock market really plays in China’s broader economy. First and foremost, China’s stock market has always remained small in proportion to the size of its economy, as well as the fact that Chinese companies are not nearly as dependent on equities for fund raising as their counterparts are in the US or UK. As previously reported by Bloomberg, China’s stock market only accounts for 11% of its M2 money supply, compared with 45% in Japan and 250% in the US. Asset allocation to financial assets (including stocks) in China is 10-15%, compared with 29% in Japan and 61% in the US.
Another major reason as to why the recent stock market free fall had a limited impact on the broader Chinese economy is due to the fact that the portion of the population that was also directly affected is relatively small. Although 50-90 million stock traders may seem like a particularly large number, when contextualized against the country’s 1.37 billion people it’s but a minor fraction. According to various surveys, just 6-8% of China’s households directly invest in stocks, as opposed to 55% in the US.
The way that the typical Chinese investment portfolio is divided up also limits the effect that volatility in the stock market can immediately have. Generally speaking, most of China’s big stock investors are from the wealthier spheres of the society who also have very diversified assets which are often grounded in property. In fact, 39% of individual wealth in China is in real estate, while bank deposits account for 46%.
“I think many commentators, particularly in the West, are comparing [the recent stock crash] to a similar plummet in the West. But like many things in China they can’t be compared like-for-like,” Tanner stated.
In the end, the wisdom of Mrs. Chao prevailed: the stock market in China is no place for amateurs. Many of the people who lost big in the recent stock volatility were of the tens of millions of new and inexperienced traders who were blown in by the winds of hype, not really the segment of the society that provides the core of China’s equity investment. As summed up by Steven McCord, “. . . naive retirees and farmers losing their entire savings are not representative of the country’s investing class.”
Although many newcomers to the market who got in on the bull run too late lost, many other investors who were in the market before, sold at the right times, or who’ve weathered the storm have earned big — especially with the central government pumping hundreds of billions of dollars into the market in an attempt to save it from slipping further.
To look at the colossal fall of China’s stock market without mitigating it against the much greater previous rise is to take a misaligned view of what has occurred. As of now, the bottom line is clear: even after the rapid collapse, China’s stock market is still higher than it was before the bull run. Massive gains in equities are not usually part of the formula that topples economies.
“I wouldn’t really consider this stock market volatility as an economic calamity,” stated Damien Ma. “This isn’t exactly the disruption of the late 1990s, when reforms of the SOEs led to some millions upon millions of laid off Chinese workers.”
Mark Tanner concluded, “Every boom is followed by a bust in stock – that is one thing that even the almighty Beijing is unable to change.”
For all the hype and doomsday predictions in the international media, five and a half months after China’s stock indexes began their drastic descent the market has corrected itself, stabilizing and returning to normal — the volatility having caused hardly a blip in the country’s broader economy. The Shanghai composite is currently rising and is at 3,456, up 27% from where it was at this time last year and the Shenzhen composite is at 2,198, up 54% year on year. The boom and bust cycle has now subsided and China’s stock market has landed in a far better place than it was before it began.
In other words, those collaspe-avists and other opportunists who have been cheerleading the downfall of China for the past two decades are going to have to continue their long wait before they can say, “I told you so.”
Versions of sections of this article appeared in the Great Debate column at Reuters in August 2015 at When the stock bubble burst, did it take the rest of China with it? and China’s stock market is like a casino, and that’s what attracts some investors.