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Déjà Vu in China’s Latest Crash

Summary:
Is it August 2015 again? In the first week of January, a spectacular Chinese stock market crash once again prompted officials to provide extraordinary stimulus measures and devalue the yuan. Just as before, gyrations in China pushed global markets deep into risk-off mode, with selloffs in Asian, European, and U.S. equities, as well as crude oil futures. The resolution is likely to be the same as it was last August, too, according to Kasper Bartholdy, Head of Emerging Market Fixed Income Strategy for Credit Suisse’s Global Capital Markets division. In short, risky assets should gradually recover as investors realize that the most recent bout of volatility is not indicative of a dangerous new threat to global growth.   China’s markets started quaking on Monday, January 4, after fresh data showed that the country’s manufacturing activity contracted for the tenth consecutive month in December. Markets were already nervous about the potential for a flood of selling activity later in the week, as a ban preventing corporations’ largest shareholders from selling stocks expires Friday, January 8. But the selling started Monday instead, with the large-cap CSI 300 index plummeting 7 percent, which then forced a halt to trading for the rest of the day. The Chinese volatility quickly spread into a global rout, prompting a 1.5 percent drop in the S&P 500, 2.

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Is it August 2015 again? In the first week of January, a spectacular Chinese stock market crash once again prompted officials to provide extraordinary stimulus measures and devalue the yuan. Just as before, gyrations in China pushed global markets deep into risk-off mode, with selloffs in Asian, European, and U.S. equities, as well as crude oil futures. The resolution is likely to be the same as it was last August, too, according to Kasper Bartholdy, Head of Emerging Market Fixed Income Strategy for Credit Suisse’s Global Capital Markets division. In short, risky assets should gradually recover as investors realize that the most recent bout of volatility is not indicative of a dangerous new threat to global growth.

 

China’s markets started quaking on Monday, January 4, after fresh data showed that the country’s manufacturing activity contracted for the tenth consecutive month in December. Markets were already nervous about the potential for a flood of selling activity later in the week, as a ban preventing corporations’ largest shareholders from selling stocks expires Friday, January 8. But the selling started Monday instead, with the large-cap CSI 300 index plummeting 7 percent, which then forced a halt to trading for the rest of the day. The Chinese volatility quickly spread into a global rout, prompting a 1.5 percent drop in the S&P 500, 2.7 percent in the MSCI Emerging Markets index, and 4.3 percent in the DAX. Oil prices slipped below $35 a barrel, the lowest level since 2004. On Tuesday, January 5, the People’s Bank of China pumped 130 billion yuan ($19.7 billion) into money markets.

 

Yesterday, Thursday, January 7, the cycle repeated itself, with regulators once again halting trading after another 7 percent drop in the market. This time, instead of adding liquidity to the market, Chinese officials devalued the currency by 0.5 percent against the dollar to 6.5646, the biggest single-day drop since the August devaluation, and leaving the yuan at its lowest level in five years. And selloffs in Asian and U.S. equities markets continued.

 

The panic in global markets would seem to suggest that the risk of a hard landing in China and the possibility of a global growth shock thereafter has increased materially. “Investors across the globe seemed to see the selling of shares in China as a signal that Chinese investors had discovered new and highly negative evidence about the state of the Chinese economy,” says Bartholdy.

 

But that conclusion would also be at odds with the facts. The fall in the Caixin manufacturing PMI, from 48.6 in November to 48.2 in December, was fairly minor and only slightly larger than consensus forecasts of as decline to 48.9. (Anything below 50 indicates a contraction.) What’s more, the reading came just a few days after the government’s official purchasing managers index (PMI) showed a slight increase in manufacturing activity. In the services sector, the same pattern held – the Caixin index showed a drop from 51.2 to 50.2, but the government’s PMI reading increased from 53.6 to 54.4. In any case, both readings showed that the services sector expanded in December.

 

Bartholdy thinks that global investors reacted so severely to China’s troubles because they were already jumpy about the possibility of a big global growth shock or China devaluing its currency to spur growth, which would put pressure on other countries to follow suit. Uninspiring economic data out of the United States surely hasn’t lifted their moods. The December manufacturing PMI came in at 48.2 on January 4, down from 48.6 in November, the sixth consecutive decline. Industrial production has also slowed in the U.S., but largely due to the struggling mining sector, rather than manufacturing.

 

Bartholdy cautions against interpreting the recent data as evidence that the risk of a global recession has increased. That’s not the same as saying there’s nothing to worry about, of course. China has built up enormous excess capacity, U.S. profit margins are stagnating, an oil glut continues to weigh on crude prices, and default rates seem likely to rise in U.S. high-yield bonds. It’s just that the new information weighing on the market isn’t earth-shaking enough for the Global Capital Markets team to set aside their forecast that oil prices will rise slowly and real GDP will grow steadily in China, Europe, and the U.S. this year. In the U.S., for example, GDP and employment figures in the second half of last year point to continuing growth. As investors realize that the manufacturing slump heard ‘round the world was not a game-changing development, they’re likely to reject the idea that it’s a credible omen of global collapse.

 

Photo of a Chinese investor walking past an electronic display showing prices of shares at a stock brokerage house in Fuyang city by Imaginechina courtesy of AP Images.

Ashley Kindergan
Ashley is an editor and writer at The Financialist. Previously, she worked as a national correspondent at The Daily, the first publication created exclusively for tablet devices, covering everything from municipal bonds to prisons. Before that, she spent five years reporting for daily newspapers in New Jersey.

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