Though the headlines screamed “China”, they mostly missed the reality of what is driving (and will continue to drive) markets. Here we explore that bigger picture.
As we said would happen months ago, once the avalanche began the headlines and commentary obsessed over the latest snowflake (China) rather than analysing why the markets are so prone to avalanche.
The Chinese casino stock market as measured by the Shanghai Composite has limited relevance to other world stock markets. It is dominated by Chinese retail investors with a gambling instinct, and financed by personal debt.
The recent devaluation of the Chinese renminbi was both predictable (can’t figure why there were so many ‘shock’ headlines), and very limited. For example, the euro and yen are off 30% from their highs; the Chinese currency came off an insignificant 3%. There is a currency war – but it’s been underway for some time, and the Chinese have been innocent bystanders.
The Chinese economy has been slowing for four years, so no new news there. In so far as the tentacles of the Chinese economy reach out around the world, the areas of greatest damage are well understood and their markets had been (correctly) hit hard before the last few days gyrations. (In fact there are good reasons to expect the Chinese economy to bounce in the Autumn, a story for another day)
So why did relatively unconnected markets fall so far, and so fast? In a nutshell because markets were already fragile, and once confidence began slipping in the East, it quickly spread West. Fear is contagious. It is just easier for the headline writers to come up with a simple reason (China), even if it is incorrect.
The problem is much more subtle than “China” and has been building for more than a decade – rising debt and ageing populations. The former sucks the oxygen out of the economy, and the latter aren’t spending as much as they once did. This means economies never quite reach escape velocity, when they can grow unsupported by central bank action. And rising stock markets (and property etc) become over-reliant on central banks continuing with emergency interest rates (now in their unprecedented 7th year).
For now the central banks will continue to pull rabbits out of the hat to support markets. One key objective of QE was to push up asset prices in the hope that this would in turn underpin the economy. So allowing asset prices to fall too much takes a key support from under economies; and the best of them are only enjoying an anaemic recovery.
This Canute-like action by central bankers will continue until voters take back control of the asylum – which is why elections in Greece and Spain are so interesting, let alone the emergence of such diverse politicians as Trump, Le Pen, Corbyn and Farage.
We continue to tread carefully.
