Economic comparisons of economic data and stock values in most first world countries appear rational. Expectations of marginal economic growth rates and earnings in general correlate well with stock prices longer term. China is one of the exceptions that conjures assumptions of major manipulation. Chinese leaders have been gradually moving toward free markets and an accepted currency to take its place as an equal to the dominant Euro and US Dollar. With unelected statist leaders directing the worlds second largest economy and profiting from their significant ownership, there has been a great deal of chicanery to achieve their goals. Communism requires tremendous information control to manage expectations and steer mass opinion so that State projected perception is reality.
A 27% Chinese stock market correction, especially over a period of a few weeks, is worrisome on its surface. However, context is required. Prior to this June peak Chinese stocks on the SSE had risen by 150% over the past year. This surge was preceded with 5 years of very quiet sideways valuations. Chinese stocks have a history of extremes that raise the specter of manipulation.Stocks prices long term rise due to perceptions and expectations of corporate earnings and stock valuations. For China the key is “managing” these perceptions. When composite Manufacturing & Service sectors as measured by the Purchasing Managers Indices (PMI) are averaging near 50 basis PMI (50=zero) we would expect to see modest GDP growth of 1 to 3%. China PMI has been showing almost zero net growth over the past 4 years basis manufacturing and very modest growth overall, yet China states their GDP has averaged almost 8% over the same period. The economy is likely slower than reported but the Communist Party continues to fine tune the growth expectations lower to maintain its image of strength as needed.
While we don’t believe China even has the ability to accurately measure their economy, the disconnect between the PMI, GDP and stock prices are stark. Chinese stocks seem to be controlled in part by a relatively small Political ownership class that dwarfs the wealth consolidation in Western countries in our opinion. While the 450% Chinese stock market rally in 2006-2007 was only “partially” justified given the clear growth of the time, the recent 150% surge in stocks from mid 2014 to 2015 had no basis in reality. Export markets were weak, Europe was still teetering upon recession, the US economy was slowing andChina’s own manufacturing has been on the verge of contraction. Impossible to prove, but the evidence strongly hints of political corruption that is indirectly managed by the Oligarchy. Time will tell how well Chinese leaders can control the 10’s of thousands of Communist insiders that may be moving stocks. Wealthy investors are cashing out after the artificial rally of the past year and authorities worried about a panic have created a cornucopia of measures to reverse the trend back up:
1) Blaming virtually non-existent short sellers by banning some brokers and investors
2) Agreements with brokers and companies to hold stock
3) Cutting interest rates
4) Speculative margin rules to borrow money are being eased to stimulate stock buying
5) Government spending of ~$20 Billion to directly Buy stocks.
6) Suspend IPO’s that would add to the supply of stock shares on the market
Today’s Greek NO vote selling of global equities may negate some of these stock propping efforts short term as confident investors enticed by State edicts are already sitting on losses Monday morning in China thanks to Greece. The real concern longer term risk is the margin debt to equity risk leverage rising beyond the Communist Party’s ability to manipulate safely.
Copper prices and the Aussie $ are additional signs of unreported weakness in the Chinese economy which their leaders work to conceal to support valuations. Australian GDP and Copper values are partly dependent upon the Chinese economy due to the tremendous Chinese consumption of copper and natural resources supplied from Down Under. A true economic turnaround in China will not occur without the Aussie $ and Copper prices resuming an uptrend. By the same token as long as these two commodities remain in severe downtrends (see below) they will remain a canary in China’s coal mine and for the globe for a potential financial contagion.
Greece will continue to capture news headlines for the foreseeable future, especially after the resounding NO vote today by Greeks rejecting austerity for a debt bailout package. However, China is currently a background concern to keep an eye upon. We suspect the Chinese still have enough levers and dictatorial power to defy reality if necessary and prevent a major market correction from becoming a long term panic. The speculative margin levels in China and the US as well as the under reporting of Chinese economic weakness raise the risk should an unseen exogenous trigger be pulled.