Up and Down Wall Street
The Great Fall of China and Its Stocks
Furious manipulation by Beijing helps pump up the nation’s stock markets, but how long will these maneuvers boost share prices? Also, it’s now Grimbo for Greece, and Yellen gets ready to testify.
By Randall W. Forsyth
July 11, 2015 1:48 a.m. ET
Confronted with a 27% loss of market value from mid-June through last Wednesday that Citigroup research estimates totaled some $4 trillion—twice the size of India’s economy—Chinese authorities went “all in,” as Evercore ISI China watcher Donald Straszheim put it.
One might have thought they already were doing whatever it takes with a blockbuster array of measures to stem the declines. Those involved conventional monetary-easing measures, including interest-rate cuts, followed by a brokers’ fund to pump money into stocks, suspension of initial public offerings, and restrictions on short-selling. Then came rather novel moves, including the suspension of trading of about half of all stocks, halts of selling by major stockholders of big listed companies, and investigation of “malicious” short-selling.
When there were allegations a year or so ago by author Michael Lewis that the U.S. stock market was “rigged” by high-frequency traders, many investors were shocked at the assertions.
Their surprise probably would be seen as naive by Chinese investors and officials.
Some major institutional investors on this side of the Pacific spoke approvingly of the measures taken to right China’s markets, which a number likened to an adolescent going through the throes typical of that age.
These investors appear sympathetic to Beijing’s view that markets are instruments of government policies, not entities that should be permitted to operate freely on the basis of some fairy-tale notions of classical Western liberalism.
Not that U.S. authorities are averse to doing the same, as noted in this column on Barrons.com recently (“America and China Seek to Collar Their Markets,” April 23). And neither are European or Japanese policy makers.
Whatever the case, it appeared by week’s end that resistance to the Beijing authorities’ exertions were futile. The Shanghai Composite bounced 5.8% on Thursday and another 4.5% on Friday, winding up 5.2% on the week.
Steve Wang, chief China economist at Reorient Capital in Hong Kong, writes that short-selling collapsed by some 75% from the peak. “That demonstrates that despite the patchy, uncoordinated, and highly criticized policies being rushed out by Chinese financial regulators, the risk-reward for going against the state is not worth the effort,” he adds. As a further indication of the regulators’ firepower, a record $13 billion flowed into China equity funds in the week ended on Wednesday, concentrated in local exchange-traded funds investing in domestic A shares, Bank of America Merrill Lynch’s strategists observed.
The impact of the China stock selloff was being dismissed as affecting only 90 million retail investors out of a nation of more than one billion people (the vast majority of whom remain in rural poverty and are unlikely to use their few dollars of daily earnings to day-trade). Yet, the knock-on impact on the real world of commodities was clear.
Part of that is technical, explains Renee Haugerud, founder and chief investment officer of the Galtere hedge funds. Copper and other commodities were used as collateral for loans, including those for stock trading, which were paid off, voluntarily or otherwise, as the market tanked.
But the slide in commodities also reflects weaker fundamentals, key among them the slowdown in the previously heady economic growth in China. Indeed, prices of many key industrial commodities have fallen near the lows hit in the wake of the 2008 financial crisis.
Barron’s trusty research maven, Teresa Vozzo, reports that copper is back to its 2009 levels and is down 45% from its peak in February 2011. Iron ore also has returned to its 2009 prices and has fallen a stunning 75% from its high, reached at the same time. Silver is off 68% from its peak in April 2011, while gold is down 39% from its September 2011 high. And, of course, crude oil has slid almost exactly 50% from its $107-a-barrel peak of about a year ago.
For an economy such as China’s, which depends on imports of these raw materials, lower prices would be expected to be an elixir. But while oil’s fall reflects the expansion of U.S. supplies, the drop in other commodities to postcrisis lows speaks more to dwindling demand.
Even if China’s stock market has found a bottom, the extraordinary measures have hurt the credibility of the nation’s officials and their reforms. Long-time bear Albert Edwards at Société Générale writes (in what he emphasizes is the “alternative view” from the bank’s house opinion) that his confidence in China—born of a previous relative lack of hubris on the part of the Chinese compared with their Western counterparts—has been shaken.
It wasn’t just the latest “thrashing around with extreme measures” or that “the state-run media are blaming short sellers and foreigners for the free fall.” Those steps will prove only temporary, he maintains. The real problem was their encouragement of a bubble fueled by individual investors and touted by the state-run media as an affirmation of government policies.
In fact, the virtual doubling of the Shanghai Composite since November was an effect of an expansionary monetary policy that pumped up a bubble, while the real economy flagged. Whether the equity market’s bounce can be sustained for more than a couple of days, especially when the stocks in which trading has been halted come back into play, remains to be seen.
THE GLOBAL MARKETS ENDED the week in Grimbo—the latest acronym, describing Greece’s state of limbo ahead of Sunday’s deadline for yet another deal for the beleaguered nation’s debt.
In a nearly incomprehensible turn of events, Alexis Tsipras’ leftist Syriza government won a stunning “no” vote in the prior weekend’s referendum on austerity measures. Then his new finance minister submitted a new proposal that appears pretty austere and close to the deal that Greece’s creditors were previously offering—which lapsed before the vote. So, after two weeks of turmoil, capital controls, and the shuttering of Greek banks, a similar offer is being considered.
That’s after some major global banks had changed their base-case outlooks to Grexit—Greece’s exit from the euro and reintroduction of the drachma—perhaps through the issuance of IOUs that would circulate as money, similar to what California did during a budget impasse a few years ago.
Will Greece and its partners in their contentious marriage of convenience decide again that it’s easier to stay together? More importantly in the short term, when will Greek banks reopen and allow the flow of money and credit needed for food and pharmaceuticals, and for businesses to pay suppliers to resume?
Until there are answers, it’s Grimbo.
A KIND OF LIMBO also gripped the New York Stock Exchange Wednesday, when a software glitch halted trading for more than three hours. But notwithstanding the breathless copy from a certain pink paper, “trading all $28 trillion of stocks listed” on the Big Board wasn’t halted, but rather continued on the various exchanges that compete with the NYSE. (Unlike the Chinese bourses, U.S. exchanges haven’t figured out how to shut down only declining stocks.)
Coming just days after physical open-outcry trading of interest-rate futures ended on the Chicago Mercantile Exchange, the NYSE halt demonstrated that classic trading floors have mainly become sets for cable financial news.
The visual aspect provides a focus for TV, while the far more serious problem of the lack of liquidity in vital credit markets does not. Yet, at a recent get-together with the head of a hedge fund, the chief of trading at a major bank, and the top investment officer of a huge pension fund, the inability to do transactions because of regulatory constraints was topic A from the first pour. But that doesn’t make good video.
After rebounding in the wake of China’s recovery, the U.S. stock market this week will have to contemplate the mundane question of earnings as the reporting of second-quarter numbers begins in earnest. As Johanna Bennett wrote in Weekday Trader, results are likely to be good enough to top forecasts of the first year-on-year decline since 2012.
Viewing the flattish showing by stocks this year, David Rosenberg, chief economist and strategist at Gluskin Sheff, sees the E (earnings) having to play catch-up to the P (price) in the market’s price/earnings ratio. Stocks have enjoyed a 15% price appreciation, while earnings growth has lagged at sub-5%, so he says a pause in a 75-month bull run is justified.
The other issue for the P/E ratio is interest rates. Federal Reserve Chair Janet Yellen is slated to give her semiannual testimony to Congress on Wednesday and Thursday, but unless she departs from the script she recited again in a speech on Friday, she’ll probably say that a rate hike should be expected later this year, depending on the economic data.
More interesting will be how she parries questions from the grand inquisitors about what could bring on the rate hikes or delay them, notably because of unpredictable events abroad.
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