When the US sneezes, the rest of the world catches a cold – or so the old saying goes.
But in recent days it has been the sickly Chinese stock market that has been blamed for infecting markets in other parts of the world.
Take Wednesday – the Shanghai Composite index fell 4.3 per cent. Other Asian markets dropped sharply and bourses in Europe initially followed suit before recovering later.
David Morrison, market strategist at GFT, says: “We have put so much emphasis on Chinese growth and this bizarre notion that this will pull the rest of the world up with it, that when cracks begin to show traders start to worry.
“The increasing wariness over the accuracy of Chinese data, and concerns that stock and property bubbles have resulted from government stimulus ‘misallocation’, have got us all turning to the Shanghai Composite each morning in a way we would never have done even a month ago.”
Fraser Howie, the Singapore-based author of Privatising China who closely follows the Shanghai markets, adds: “China’s markets have become much more influential and correlated with other markets, not just in Asia but all over the world.
“This is because China is the only big economy in the world that is growing strongly. It is contributing more to world gross domestic product than before, so its markets have become more important to investors.”
This is a change because for many years the performance of Chinese and western equities was not correlated. There were good reasons for this, including the relative isolation of the Chinese market. It is very hard, for example, for western investors to buy Chinese A shares, as opposed to H shares which are traded in Hong Kong and which can be bought by foreigners.
Analysts say there have been a number of occasions in the past two years when falls in Chinese equities have sent tremors through other markets. One was on February 26 2007, when the Chinese market fell almost 9 per cent. But the opposite is also true. Last November Chinese markets began to recover following the announcement of the country’s massive $568bn stimulus programme, which presaged the recovery in western markets.
Since January 2008, the Shanghai Composite has moved in the same direction as the S&P 500 on 16 out of 20 months – a correlation of 80 per cent. Between January 2002 and December 2007, it moved in the same direction in 37 out of 84 months – a correlation of only 45 per cent.
The correlation is even greater between China and other Asian markets, with the Shanghai Composite moving in the same direction as the FTSE Asia Pacific index on 17 out of the past 20 months – an 85 per cent correlation.
But it is not just equities that have been influenced by China’s stock markets.
As Chinese equities have become a barometer for risk appetite, they have increasingly helped move currency and commodity markets. Both commodity and emerging market currencies, such as the South African rand and the Brazilian real, often take their cue from Chinese equities. Steve Barrow, a currencies strategist at Standard Bank, says: “It is our view that a sustained and serious bout of global risk aversion is only likely to come from China, not elsewhere.” However, China is not about to take over from the US as the benchmark market.
In fact, analysts warn that putting too much faith in Chinese equities as a bellwether would be foolish as they are closed to foreign investors, and consequently not such a good indicator of sentiment as open markets. They are also still very small compared with the developed exchanges in the US and Europe. For example, the US markets make up 41 per cent of the market capitalisation of the FTSE All World index. China only makes up 1.48 per cent.
Robert Buckland, equity strategist at Citigroup, says: “China’s economy is very important, but we are less convinced that Chinese stocks matter as much. Recent falls in stocks have been about investors looking for an excuse to take profits rather than really thinking the fall in China will start a sustained downward trend.
“Chinese markets are just not mature or big enough to displace the S&P 500. Maybe they will be in a few decades, but not yet.”
Mr Howie agrees: “It makes no sense for investors to follow the Chinese markets. They are very immature in that they do not have a large pension fund market or a solid base of investors like those in the west.
“They went up more than 90 per cent at one point this year, but that was artificial as money has found its way into stocks because of the huge amount of credit that has been made available by the banks at the behest of the authorities. This is a market driven by liquidity.”
Nigel Rendell, senior emerging market strategist at RBC Capital Markets, says: “China is now in effect in a bear market [a 20 per cent fall from recent peak to trough]. This has happened in just two weeks, so we have to be at least a little concerned.
“But we don’t think the market will necessarily fall a lot further. If you look at valuations, then the market looks fairly priced. Trailing price earnings multiples on the Shanghai Composite rose to 51.99 in October 2007. They are now 29.78. That is encouraging because if China falters, then the world recovery will do too. China’s markets may have not replaced the US just yet, but they are a big factor in determining sentiment.”
