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Forget Greece, Chinese Stock Market Crash the real worry

By Cees Bruggemans

Forget the Greek crisis. The real disruption now is Chinese stock market panic and an old-fashioned bear market flooring overvalued stocks.

Greece was never an economic story, but it was a financial story. In the case of China, it too is foremost a financial story, but with crunching ability in the economic sector, especially global commodities as fear about Chinese growth revives once again.

Chinese uncertainty is now by far the greater global story.

Greece only represents 2% of the European economy. Its trading links in the greater European context are minimal. Just so its trade with South Africa.

There remain questions about financial contagion. Especially in European bond markets, with risky peripheral spreads rising, and equities selling off, while the safe haven Bund yields have fallen anew.

Despite these ripples going through European bond and equity markets, there is the background presence of the ECB, and the clear intention to do “whatever it takes” to preserve financial stability, if it were to be needed.

In particular, the ECB now has the firepower to step up bond buying. Such QE (quantitative easing) in the Fed mould would serve to stabilise government bond markets, in turn potentially anchoring equity markets (though not necessarily individual shares).

Market sentiment about Greece is simple: digestible, not worth the trouble. So the enormity facing Greece is an internal matter. Europe can live without Greece and manage the transition with ease, even if costly.

Even so, the politicians are not finished talking, with a ‘final’ attempt pencilled in for this coming Sunday, to hear Greek pleas, make European reform demands, and see whether this circle can still be squared after many failed attempts..

On 23 July, a ECB repayment of €3.5bn looms. With the ECB having frozen liquidity assistance, and Greek banking pressure rapidly mounting, the thumb screws are now fully applied.

Either Greece buckles to reform demands or a reluctant Grexit is set in motion. The real blame game will be about “who lost Greece”. European politicians are trying to make sure the focus will be on the Greek government.

How different the Chinese situation. There, unease was always focused on the high level of indebtedness. Instead of this becoming crisis-activated, Chinese stock markets have turned out to be crisis-prone.

A year of wild living in Chinese stock markets has driven equity valuations to speculative heights, with in some instances company price/earnings ratios “in the thousands”. That invited a flood of millions of Chinese to open new equity trading accounts, borrowing heavily, trading aggressively on margin. Reportedly, over a million new Chinese millionaires were created this way in the past year, with the stock market froth also feeding Chinese consumption spending.

This happy picture changed dramatically in the course of the past four weeks, with over $3 trillion in Chinese equity valuation wiped out. That’s over 15 times Greece’s annual GDP of just over $200bn annually. That puts things a bit more in perspective, both magnitude & time scale.

With the Chinese markets changing direction, a lot of unstable new ‘wealth’ is liable to panic easily. The market shakedown then tends to start feeding on itself, with increased margin calls further drying up liquidity.

What therefore is happening in Chinese stock markets is as old as capitalist trading. There have been attempts to stop the rout by piecemeal intervention, such as getting large Chinese institutions to commit to bigger purchases, raising insurance company investment limits, trying to stem panicky sentiment. This has favoured blue chips but not the smaller caps where most retail newcomers are concentrated doing the panicking.

Chinese companies have responded in unprecedented numbers by having trading in their shares suspended, with over half all listed companies now so affected, representing some 40% of market cap.

But this attempt to cool things down only takes yet more liquidity off the table, people cannot sell those particular shares, and focus their selling on what then remains, re-channeling but not stopping the rout.

Market commentary is for another 20% to be sold off to get back to November (start) levels. With anxiety in full flood, little will seemingly stop this sell off.

Only a concerted “major” policy action, in the Fed or ECB quantitative easing (QE) mould, might turn such negative sentiment, stabilise prices and allow resumption of more normal trading conditions.

But we aren’t there yet, the authorities are still only working with piecemeal actions, still learning the capitalist market ropes while as yet unwilling to roll out the Big Gun QE policy intervention, perhaps partially out of concern for what happened in 2009 when unprecedented money supply creation (debt) was allowed to address the global crisis spillover, with severe excesses resulting.

They are not looking for a repeat of THAT, yet now face a falling knife in these panicking equity markets.

The good news is that Chinese mainland equity markets remain closed off, are not fully integrated globally and are the main retail story where the real panic is concentrated. In contrast, Hong Kong is globally integrated but mainly an institutional story.

The greater world has been mildly selling off, too, as global equity sentiment has been negatively affected by this Chinese havoc (favouring bond safe haven yields easing), but the global correction has remained orderly and moderate, so far, as China’s equity actions are mostly seen as an internal matter.

Unlike the European situation, however, where markets were never wildly overvalued and the ECB is seen as a willing major interventionist, if need be bomb-blanketing any Greek sentiment fallout, the Chinese PboC is yet to convince that it can stabilise an overpriced equity bear market and is willing to really do so.

One upshot has been (further) downgrading of Chinese growth prospects and this sentiment deterioration hitting global commodity markets.

The good news is that Brent oil fell back into the mid-fifties, the bad news is that the prices of iron ore, copper, aluminum, platinum, gold & other commodities have also been pummeled heavily.

This directly hits exposed Emerging Market commodity producers, including South Africa, creating weakening potential for the Rand, adding to our domestic inflation pressures, and coming at an awkward time for mining union wage negotiations.

Our main exposure is therefore global sentiment in a direct sense (equity markets orderly retreating), and indirectly a potentially bigger exposure for our natural resource counters via falling Dollar commodity prices, with this having greater domestic knock-on effects via weaker Rand, higher inflation.

So far, the Chinese market correction is less than a month old and policy intervention has been ineffective. More time may be needed to fully shake out, alternatively to mobilise Chinese macro policy in a major way.

For the duration, world markets will likely react uneasily, even though hardly fully involved.

* Cees Bruggemans is the Consultant economist at Bruggemans & Associates. His Website is  www.bruggemans.co.za and you can email him via economics@bruggemans.co.za

* For more in-depth business news, visit biznews.com or simply sign up for the daily newsletter.

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