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July 12, 2015

The Many Differences of China and Greece

This summer has not been kind to the Chinese markets. Since mid-June, nearly 30% of the market capitalization of Chinese stocks has vanished into the ether. (The Shanghai Stock Exchange Composite is down by about 28% since June 12, 2015.) Reuters says trading halts have been placed on about 1,500 stocks listed on the Shanghai and Shenzhen exchanges. To put this number in perspective, the value of these companies equates to about half of the Chinese market.

This downward plunge would normally dominate the financial headlines. However, another problem several thousand miles to the west has been taking up space on the front page: Greece. Last Sunday’s “No” vote on the austerity referendum has left the country’s and the eurozone’s future in question. In a sign of the times, yesterday an acquaintance of mine said to me, “You must be pretty busy with what’s going on with Greece.” No mention of China. My assumption is that he’s not alone.
Source: http://nicholsoncartoons.com.au/

I’m not going to say much about Greece, other than that it’s a small country and its problems have been well-known for years. Beyond that, anything I could say would be pure speculation. I simply don’t know what is going to happen, and neither does anybody else. An Italian newspaper quoted European Central Bank President Mario Draghi describing the odds of finding a solution as “I don’t know, this time it is really difficult.”

History is not giving us much insight either. Business radio program Marketplace said that the last example of a unified currency falling apart was the Habsberg Empire’s gulden and krona, which lasted from the 1750s to around the end of World War I. Given the changes that have happened since then, it’s far from an ideal example to rely on.

History is also being used to draw parallels between China and the United States. Bloomberg published a chart last week comparing this year’s movement in the Shanghai Composite to the Dow Jones industrial average movement in 1929. The headline of the article was, “China Brokers Dust Off Wall Street Playbook From 1929 Crash.” The Wall Street Journal quoted a 32-year old college art teacher in Nanjing, Sophie Wang, as saying,
“I don’t really follow news on stocks that closely. My hairdresser said it was still a bull market and I needed to get in.” 
The quote conjures up images of the ticker tape machines reportedly installed in some U.S. hair salons during the 1920s.

As strong as these comparisons seem, there are very big differences. China’s central government exerts a strong influence over its economy and the financial markets, unlike the U.S. government—particularly in the 1920s. Margin requirements are higher in China than they were in the 1920s United States. Earlier this year, The Financial Times said that Chinese regulators require an initial margin of at least 50% with a minimum account balance of Rmb500,000 (about $80,000 in U.S. dollars). Reuters reports the Chinese government as now barring shareholders from owning more than 5% of a company’s stock and from selling shares for the next six months, suspending initial public offerings (IPOs), easing margin terms, enlisting brokers to buy stocks and investigating “malicious” selling of shares by short sellers.

The government’s involvement does not change one important fact, however: China has many relatively new investors who likely lack any knowledge of global market history. While it may be tempting to snicker at Sophie Wang’s hairdresser’s comment, the reality is that the capital market system is still fairly new in China. The country has not experienced the type of capitalist booms and busts the U.S. has. Plus, it’s unclear how many books about asset bubbles and financial busts (such as Charles Mackay’s classic “Extraordinary Delusions and the Madness of Crowds”) are available, much less read, on the mainland. In other words, there are a lot of investors in China, like Sophie Wang, who are unaccustomed to the big downward moves.

As scary as the moves in China look, the good news is that so far there has not been global contagion. Rather, correlations between Chinese stocks and global stocks are just slightly above zero, after previously having been negative, according to a chart tweeted by BlackRock today. While commodity prices have been hurt, the national indexes of other large economies—including the U.S. and Japan—have not been affected overall. Given the Greek crisis, it is very difficult to discern any impact on the European markets from China. As far as other BRIC indexes go, Brazil, India and Russia have all been struggling with their own internal issues, making it difficult to attribute any weakness directly to China. (To be fair, Brazil has been impacted by weakness in commodity prices, but the country is also coping with domestic political issues too.)

It’s also worthwhile to note that China’s economy is still growing at a pretty good pace, and market drops tend to be comparatively short-lived. The drops are painful, but shorter in duration than upward moves. These facts will likely not make headlines right now (nor will the size of Greece’s economy relative to the rest of the European Union and the world), but they are worth keeping in mind.

The Week Ahead

Nearly 40 members of the S&P 500 will report earnings next week as second-quarter earnings season starts to warm up. Included in this group are Dow Jones industrial average components Johnson & Johnson (JNJ) and JPMorgan Chase & Co. (JPM) on Tuesday; Intel Corp. (INTC) on Wednesday; Goldman Sachs Group (GS) and UnitedHealth Group (UNH) on Thursday; and General Electric Company (GE) on Friday.

The first economic reports of note will be June retail sales, June import and export prices and May business inventories, which will be released on Tuesday. Wednesday will feature the June Producer Price Index (PPI), June industrial production and capacity utilization, the July Empire State Manufacturing Survey and the Federal Reserve’s periodic Beige Book. The July Philadelphia Fed survey and the National Association of Home Builders July housing market index will be released on Thursday. Friday will feature the June Consumer Price Index (CPI), June housing starts and building permits and the University of Michigan’s preliminary Consumer Sentiment survey.

Federal Reserve Chair Janet Yellen will give her semiannual monetary testimony to House and Senate committees on Wednesday and Thursday, respectively. Cleveland president Loretta Mester and San Francisco president John Williams will also make public appearances on Wednesday.

July stock options will expire on Friday.

About The Author - Charles Rotblut, CFA is  the VP and Editor for American Association of Individual Investors (AAII).  Charles is also the author of Better Good than Lucky.  (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

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