Monday morning headlines were more sobering than a double shot of espresso, adding anxiety to an already tumultuous few weeks in China. The Shanghai index dropped 8.5%, in one day, again. This after a see-saw struggle to regain momentum with similar drops from mid-June’s dizzying peak of over 5,000.
The consequences of such a serious correction, with a Monday close at 3209.91, are neither dire nor surprising and the ensuing panic will likely bring out a host of incorrect linkages.
Here are three misconceptions of what the crash seems to mean, but doesn’t.
1. The China market crash will destroy the U.S. economy
U.S. exports to China totaled a mere 7% of total U.S. exports year to date. Canada and Mexico represent a combined 34%.
Exports in general make up an extremely small percentage of the U.S. $18 trillion economy (about 8%) and exports to China represent an even smaller amount.
Over two-thirds of all U.S. economic activity is driven by consumers. The biggest impact on that activity is whether people feel they have more money to spend today than yesterday, not on whether day traders in Pudong are pulling their money out of Sinopec shares.
2. Shanghai and Shenzhen stock markets represent the broader Chinese economy
Usually a broad-based stock market sell-off represents a belief that the underlying economy isn’t going to do as well going forward as it has in the past. That’s the rational explanation assuming near perfect knowledge of economic conditions. Even the U.S. market doesn’t work that efficiently (there are sell-offs even without new negative economic information.)
In China, knowledge of the broader economic slowdown has been around for a while. If the markets were rational they should have been dropping when the government announced lower growth targets back in March. They should have dropped as alternate economic measures hinted that the official 7% growth rate might not be reached.
Instead they continued to climb based primarily on two non-economic beliefs. The self-fulfilling prophecy that the market could only go up and that the Chinese government would prop up any market weakness. Win-win.
Since domestic savers have very limited choices of where to put their money, once the real estate two-step dance was over (buy one to live-in, buy one to hold) the stock market became the only game in town attracting a flood of capital. That rush caused prices to rise which attracted even more investment, much of it borrowed on margin. Thus the illusion of a perpetually rising market.
The Shanghai composite has now dropped below the magical 3,500 level where many believed the Chinese government would step in with massive buying to push prices back up. The illusion of invincibility appears to be faltering. Meanwhile online sales in the real economy continue to expand.
In this market there is no irrational exuberance with Chinese characteristics, just irrational exuberance as rationality returns to the market.
3. The China sell-off is similar to previous Asian financial crises
In 1997 the Thai Baht came under heavy pressure resulting in large scale contagion throughout the region. A heavily reliance on trade with a market-determined exchange rates drove this spread. China has neither.
China’s yuan, despite recent changes, remains a managed currency. The government still decides on its opening daily price. That means speculators cannot significantly alter its value beyond a government imposed trading band of +/- 2 percent per day.
China’s economy is also far less reliant on trade than in the past as government investment in infrastructure as well as real estate development have become main drivers of growth. Of those industries dependent on trade China’s recent devaluation made Chinese exports cheaper (a dollar or euro buys more today than in the recent past).
What does the recent sell-off really tell us?
The Chinese government is going to have an increasingly difficult time trying to stop the carnage. Despite conventional wisdom, it does not have unlimited power. By even trying to manage the sell-off, policymakers have placed themselves in an extremely difficult situation.
If they can’t right the market as people expect the government looks weak. If they impose even more draconian rules to stop sellers from liquidating they may kill interest in the market as a whole. Lose-lose.
Apple’s Tim Cook, for one is not that concerned about purchasing habits in China. Let’s hope that the nascent middle class has more cash stashed at home that they’re willing to spend than most people think.
Meanwhile the China market crash has caused a flash sale on a host of solid U.S. equities.