It could be worse. You could own Greek sovereign debt.
No doubt it’s been an interesting weekend. On the heels of last week’s sharp decline on the Chinese stock markets, the People’s Bank of China took a page from the playbook of former US Federal Reserve Chairman Alan Greenspan.
In an effort to stabilize the markets, the PBOC on Saturday sprang into action and instituted the “Zhou put.” Essentially, it put a floor to how low it will let the market fall. It cut interest rates for the fourth time since November, by 0.25% to 4.85%, and loosened bank reserve requirements by 0.5% to 2%. Both actions were the first of their kind.
The central bank explained that China’s economy is in a transition phase and that it needs to take action to stabilize growth, restructure the economy, institute reforms that help citizens and lower risk.
Yeah, all that stuff is true. But that argument might have carried more weight if it hadn’t happened the day after a two-week period during which a fifth of the Chinese market’s value evaporated.
The main reason for last week’s decline was a drop in liquidity. The biggest factor here was the lowering of margin financing. It looks like investors had to sell to cover their margin calls. Throw in some high liquidity lockups in subscriptions for initial public offerings, a 30% week-over-week drop in new account openings, and disappointment that there was no rate cut earlier. Altogether, it gave offshore investors a good reason to take profits off the table. This perfect storm sent the market close to the 20% decline denoting a “bear” market,
If the PBOC wanted to inject liquidity and stabilized the stock market, it didn’t have the intended effect on Monday. The Shanghai Stock Exchange Composite Index fell 3.3% to 4,053, a 22% decline from its June 12 high. This puts it squarely bear territory. The Shenzhen Stock Exchange Composite Index, which was already down 20% on Friday, tumbled an additional 6%. The ChiNext Index of small-cap stocks sank 7.9%.
Of course, markets around the world fell Monday on fears the Greek debt crisis will spread like a contagion. Over the weekend Greece closed its banks. So we’ll have to give the Chinese rate cut a little more time to sink in.
So here’s where Asia Unhedged stands. China’s longer-term fundamentals are sound as the financial system continues to be reformed at a fast pace. In addition, the economic transition toward a much larger services sector is in full swing. But the PBOC has to stop experimenting with useless and dangerous fine-tuning exercises. It needs to clearly spell out its policy goals and let the markets know what it’s doing and why.
We predict a market recovery in the coming weeks. Liquidity will return in July and we expect the Shanghai Composite to trade between 4,200 and 4,800 for the foreseeable future.
On a side note, buy Japan stocks. It’s our favorite market at the moment. Consumption and capital expenditures are stabilizing. There was even a small pickup in inflation in May according to latest figures. Don’t expect huge jumps from the Japanese economy, but today all is well. The US dollar has remained in a narrow range with the yen since mid-May and — if anything– is likely to move higher as the date of the first US rate hike gets closer. These factors will prove supportive of Japanese equities in the second half of the year.