China’s stock market and a cautionary tale against market overreaction

Global markets are nervously watching China, where the local market has fallen nearly 20% in three days. From its peak in mid-June, China’s local market has fallen 40% and is now in negative territory since the start of the year (though still up 30% over 12 months).

China’s devaluation of its currency this month has certainly raised fears that the country is experiencing a stumble in growth – no doubt backed by recent weak economic data. We’ve seen global markets fall sharply in sympathy – the US market has fallen 8% since Thursday, and Europe is down 4% (after bouncing on Tuesday).

In a bid to stimulate the economy, China’s central bank cut interest rates again this week (for the fifth time since November) as well as the banks’ Reserve Ratio Requirement.

In our view, the China slowdown shouldn’t come as a surprise. Markets have had enough time to factor in slowing GDP growth and industrial production, weaker commodity prices, monetary easing and liquidity provisioning. Although the recent Yuan devaluation has impacted other emerging market currencies, it doesn’t necessarily signal that China is heading for a hard landing.

It’s also worth remembering that China is in the process of transitioning to an economy that’s less dependent on Fixed Asset Investment. A rising Middle Class, not just in China but across Asia more broadly, remains a longer term investment opportunity as domestic consumption grows. As investment shifts from fixed to consumption based assets, the sectors worth monitoring include fashion, financial services, technology and tourism.

For the moment though, a weaker currency should help the ailing export sector and the prospect of further monetary easing and targeted infrastructure spending could all act to stabilise the Chinese economy in the coming months.

Volatility can be expected in the future but not necessarily feared. A well diversified portfolio remains a good starting point to mitigate risk, but for those who remain cautious on equity markets, investing in low volatility equity funds is another way of gaining exposure to shares without riding the highs and lows of market sentiment.

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