Both A-shares and H-shares entered a bear market this week with declines in excess of 20% from their late January peak. China will blame US President Donald Trump for firing the first shots in a trade war and spooking the Chinese stock market, and rightly so: China’s stock market wobbled in direct response to announcements and leaks from the White House.
Inadvertently, Trump has done Chinese Premier Xi Jinping a gigantic favor. China’s long-overdue reduction of leverage had to put pressure on stock prices in any event, and Trump’s trade threats allow Beijing to shift the blame to the barbarian on the border rather than the imperial palace.
As the chart makes clear, the post-2007 decline in the Shanghai Composite Index followed a decline in corporate leverage, and its post-2013 recovery followed a rise in leverage (measured by the ratio of net debt to earnings before interest, taxes, depreciation and amortization). By 2016 the Shanghai Composite was levered nearly 4:1. That’s nothing to panic about: leverage in America’s small-cap Russell 2000 index reached 6:1 before falling to 4:1 in 2017. Leverage on the S&P 500 is only 1.5:1, but the ratio is skewed by a handful of cash-rich tech companies who are major net lenders. Excluding the least-levered 100 members of the S&P 500, the remaining 400 members have a leverage ratio of 3.5:1, not much different than the Shanghai Composite.
Nonetheless, the Chinese government is determined to reduce leverage, for a number of good reasons. First, leverage and the potential for nonperforming loans is concentrated in less-productive older industries that the banks have kept on life support. Second, the so-called Shadow Banking sector has funded dodgier ventures at high interest rates; although it represents a small part of the total banking system, it is large enough to be a concern.
The growth rate of shadow banking reached an alarming 45% in 2013 before falling to around zero this year. The growth rate of overall lending declined from around 16% in 2012 to about 12.6% today.
Leverage in the short-term multiplies earnings, and the stock market usually likes it. Deleveraging usually involves issuing more equity (diluting existing shareholders) to pay debt, and the stock market usually doesn’t like it.
China’s industrial profits are strong, and the Shanghai Composite is not overpriced at 11 times forward earnings. But it faced a stiff headwind due to de-levering. Now Beijing can blame it all on Trump.
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Sovereigns, Administrations, Emperors, Regimes are tough, but ecenomics is always sensitive, dynamic & fluid. Every action will have a reaction.
Trump or no Trump, China’s planners are to be held responsible for not taking corrective steps earlier on. This problem was clearly identified before Trump’s accession to the WH.
Once an IPO is done, stock market is an arena for the speculators/investors to slaughter each other for zero-sum gains, the activities in the stock market is detached from the company’s real operations. But this reality is purposely hid from the public in the West, so the rentier class like the Wall St. and other financial parasites can plunder the 99% with self-righteous on the moral high ground and claim as the elite of the society.
China treats the stock market as it is, other than IPOs the majority of the stock market activities are harmful to the national financial, culture and mental health, the speculative activities in the stock market needs to be controlled and discouraged; stock market crashes from time to time is a necessary mechanism to keep the speculators in check and the investment environment healthy. Donald Trump’s trade war with China allows China to weed out a large batch of rotten speculators in the stock market by blaming the American, perhaps China should give Donald Trump a medal of contribution.
Remember Chauncy Gardner in the film "Being There".. and his advice to the fictional president: "In the garden, growth has it seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again….As long as the roots are not severed, all is well. And all will be well in the garden.”
Mr. G, glad to see you’re writing more… we need your observations.
The writer is projecting. I’ve never seen China blame anyone in their diplomatic communiques or speeches.
Unlike the Americans who blames everything that’s wrong with America on everybody but themselves. It’s like comparing a responsible adult with a petulant three year old.
The whole World, including Americans , will blame Trump for ruining the economy, because that’s what he did: ruining trades and businesses.
Speculative activities in stock markets in China do not have the same importance as in American and European countries. A bear market or a bull market has only a marginal effect on the real economy and on the wealth of Chinese individuals and institutions.