China’s uncertain markets makes it a long term play
The eyes of the world are on China this week, as the Olympics gets under way.
Last year the Chinese stock market tried to break the high-jump record, as the Shanghai Composite hit its highest ever level in October – rising more than 400 per cent in two years.
But this year, it seems to have entered some of the diving competitions instead. There has been a dramatic correction from the highs of 2007. On Monday, just as the Games got under way, the Shanghai Composite fell to its lowest level for 19 months. The index has plunged to 2,470, down 60 per cent from its peak.
A Familiar Problem
Of course, markets around the world have fallen sharply over the past year, but China faces its own set of problems. Chinese and international investors are worried about rising inflation and slowing economic growth. This is a familiar combination in the UK too, but the situation is more worrying in China. The market is sufficiently concerned to ignore falling oil prices, which have boosted equity markets elsewhere. The Chinese government cut tax on equity trading in April in an attempt to boost the market (having tripled it in 2007) but that hasn’t helped either.
Despite the slump in stock prices, China still has some of the largest companies in the world. For us, the main issue remains inflation. Demand is less of a problem. While exports to the rest of the world are weakening, home-grown demand for China’s goods still looks reasonably strong.
Inflation has begun to fall; in July, consumer price inflation dropped for the third month in a row to reach 6.3 per cent. But this is still high, and the pace of change is slower than the authorities would like. A key piece of good news would be if lower food prices help move headline inflation closer to, or below, five per cent. That would be pretty much back inside the government’s comfort zone.
Corporate Woes
At the corporate level, there are widespread reports of companies running into difficulties. This is partly due to inflation: though the cost of materials is rising, businesses have limited scope to raise their prices.
But the underlying story is less negative, and may be the result of an intentional policy of squeezing out the bottom end of the production chain and the lowest value-added companies.
China has grown wealthy enough to say no to some kinds of high-polluting or dangerous production.
This has undoubtedly been China’s decade. But despite this year’s fall in the equity market, valuations are still high relative to the rest of the emerging markets. And the combination of high inflation and economic risks makes China a less appealing investment than other emerging markets, particularly its competitors Brazil and Russia.
For now, China should only be regarded as a long-term investment – an entry for the marathon, not the 100 metres.