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The Great Fall of China

The Chinese stock market returned c.82% over the 12 months to 30 June 2015, fuelled by cheap borrowing and a government initiative to increase institutional and retail investing alike (there are now more than 90 million individual investors in the Chinese stock market, higher than the number of Communist Party members).

On the face of it, promoting growth in the stock market to enable companies to borrow cheaply appeared to be a good idea. However, having daily stock market trading dominated by retail investors has left the Chinese economy exposed to large, sentiment driven, swings. Since its peak on 14 June 2015, the Shanghai Stock Exchange Composite Index lost 28% (representing c.$3.6 trillion in market value; more than the economic output of France). The sharp fall in Chinese equities has resulted in trading suspensions for more than 1,400 companies, locking out investors wishing to sell their investments.

Such falls create substantial volatility in world markets, although they are not necessarily a bad thing. Given the strong performance of the Chinese equity market, there had to come a point where people would begin to take profits; “a pause for breath”. The situation is extremely volatile, and a further slowdown in the Chinese economy might cause financial distress to world markets (particularly those economies that are reliant on commodities), as China is one of the largest contributors to global economic growth and output.

There is much talk about whether the Chinese stock market is in a bubble and considerable concern as to whether: (i) recent government interventions (e.g. through interest rate cuts, money market cash injections etc.); and (ii) the tools available to the government would be enough to prevent this bubble from bursting, as market swings are being driven by sentiment (and worsened by those individual investors who borrowed money to invest in the first place). The consensus view (for the time being) appears to be that the recent downturn has presented investment managers with a buying opportunity, and that further monetary support and reforms should support economic growth, which in turn should bring investors back to the market.

Whilst clients’ current direct exposure to Chinese equities is limited, we continue to monitor the
situation as it evolves, as a slowdown in China could have a wider impact on global economic
growth. We will issue updates as and when the situation calls for it.