Role of harbinger
Whether it's the mark of a new bear or just a big-time correction, the sell-off of Chinese equities in the past month on rising concerns about the country's future economic growth has left markets around the world on edge.
Considering China's role in recent history as a proficient indicator of the direction in global markets, it's little wonder investors are spooked.
However, now is not the time to panic.
While China's economic recovery is apparently in overdrive, here in North America we may only just be getting started.
"It's a very legitimate concern, because the Chinese market did indeed lead the most recent top and bottom of markets," said Chen Zhao, market strategist at BCA Research Inc. in Montreal.
"But they moved much faster and much more aggressively than us this time around. Even if the Chinese market keeps going down, we are probably not going to follow right away."
Yesterday, global stock markets sold off after the Shanghai composite index dropped another 6.71% to close at a three-month low of 2,667.75.
With yesterday's drop, the Shanghai index has fallen 23% since Aug. 4 as concerns about the country's growth prospects have mounted.
Compared with the rest of the world, China's economy has been in overdrive this past year, fuelled by a credit expansion that topped US$1-trillion in the first half of 2009 and infrastructure development that has cost more than US$500-billion.
But in early August, government officials expressed concerns about an overheated economy and vowed to reduce lending.
Given that China is now the world's third-largest economy and the world's leading exporter, the measures to curb growth in the country are seen as a potential threat to global economic recovery, especially for such countries as Canada that are dependent on China's high demand for commodities.
"A lot of the run-up in stock markets over the past five months has been based on growth expectations for 2010 and 2011 that are priced for a pretty strong recovery," said Robert Kavcic, BMO Capital Markets economist. "If China tightens in the reins a little too much, it might choke off that recovery."
In Toronto, the S&P/TSX composite fell 1% to close at 10,868.21, while the S&P 500 in New York shed less than 1% to close at 1,020.62. The two exchanges faired relatively well in August, rising slightly as encouraging economic data in North America and Europe have combined with solid corporate earnings on both sides of the border.
Chen Zhao says that for the most part the sell-off in China reflects the fact the country's economy and markets have recovered much more dramatically and much more rapidly than most other world economies because China acted to stimulate the economy much quicker than anybody else. As a result, China also moved first to tighten monetary policy.
"The market is not concerned about growth per se, but the risk of China's monetary policy, which is changing," he said. "Here in North America, the economy recovery has not unfolded nearly as quickly, and we still need to see clear evidence that the economy indeed is recovering. Until it does, I don't see the U.S. Fed doing anything for at least three to six months."
Recent history suggests China's benchmark exchange leads the eventual direction of the TSX by four to six months.
The Shanghai composite peaked on Jan. 14, 2008 at 5,497.901, then fell 68.96% to 1,706.703, its market bottom, on Nov. 4, 2008. From there, the Chinese benchmark climbed 103.40% to 3,471.442 on Aug. 4.
Meanwhile, Canada's benchmark peaked on June 18, 2008 at 15,073.13 and bottomed on March 9 at 7,566.94, down 50%. Since then, the TSX has climbed as much as 45.99% to a high of 11,046.93 on Aug 5.
For David Rosenberg, chief strategist and economist at Gluskin Sheff and Assoicates in Toronto, it also seems premature to look at the Chinese market's recent woes and say game over for the rest of the globe's stocks. For one, the Chinese market is much more volatile than developed-world markets tend to be, and 20% swings are not unheard of, he says.
But while he doesn't look at China and see reason to call for a major economic setback, he does note that some of the latest export data from the country have been disappointing. When combined with slowing global freight and cargo rates, it puts in question a widespread view that we were entering into a broadly based inventory cycle.
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