investment update

China’s equity market correction impact on AvSuper

July 2015
Markets have returned to the headlines over recent weeks as investors’ confidence has been challenged by market and policy developments on two continents. We recently shared our thoughts on implications for investment strategy in our update on the Greek debt crisis. Now we review that ‘other headline story’ which has centred on the recent boom and correction in China’s onshore equity markets.

The financial implications of the equity market correction in China have significantly influenced equity market performance, including the performance of your AvSuper investments. We hope the following information assists your understanding of the situation as it stands.

AvSuper has little direct exposure to the China equity market, however the Chinese market situation has had a downward impact on Australian and international investment markets generally. 

What’s happening in China

China’s onshore equity markets in Shanghai and Shenzhen delivered extraordinary returns over the 12 months to June 2015.  Share prices rose strongly but steadily in the first 9 months then doubled in price in between May and June, fuelled by an explosion in margin lending to inexperienced retail investors.  By mid-June the Shanghai market had risen by around 150% from June 2014 levels. 

In June 2015, valuations looked extremely stretched in a number of sectors for underlying earnings prospects.  Many market commentators identified the Chinese share market as showing the hallmarks of a speculative ‘bubble’.

The sudden surge in new retail investor trading accounts in 2015 is captured in the first chart below, while the second chart shows the sharp increase in margin debt outstanding as a percentage of investable equity market capitalisation which, at 9%, was among the highest in the world.  

China weekly new A share stock-trading accounts
China margin debt outstanding

 

In early 2015, the surging share market also had the attention of Chinese regulators which took steps to increase surveillance and regulation in relation to margin lending. By early June, the China Securities Regulatory Commission (CSRC) had stepped up efforts aimed at cooling speculative activity with further measures including the development of draft rules to limit margin trading and short selling businesses.

By mid-June the speculative bubble began to deflate with the market falling over 30% in a few weeks. The forced deleveraging of margin lending positions is now amplifying the selling pressure.

China Shanghai A Share

Source: JANA / Factset

 

The impact on Australia

Given the significance of China to global growth and to Australia’s prospects in particular, recent developments are potentially a cause for concern – particularly as sharp stock market declines are often viewed by investors as a leading indicator of weaker prospects for corporates and for the broader economy.

In the case of China, however, we believe there are a number of reasons why the stock market is of limited importance as a leading economic indicator and, notwithstanding its size, why China’s recent market ‘collapse’ should have less of a direct economic impact in China and more broadly than might be the case for a collapse in a large developed market.

The following points are key to our view:

1. China’s stock markets are not representative of the economy

The composition of the Chinese share market is not very representative of their economy or its reorientation towards a domestic consumption led growth model. Older State-owned enterprises represent a disproportionately large weight in equity indices with smaller fast growing ‘new economy’ IT, consumer and healthcare sectors representing only approximately 10% of index market capitalisation. Thus share market performance is not highly correlated with China’s economic activity.

2. China’s stock markets are of limited value as a leading indicator

In terms of Chinese equity market movements signalling changes in corporate and economic prospects, there are a range of reasons to discount the quality of the market’s assessment. Unlike in more developed markets, institutional investors are a minor presence in China where individual retail investors account for around 80% of daily trading volumes. A large proportion of these retail investors have very limited investment experience. We believe this combination of non-fundamental factors driving China’s equity market performance means shifts in market pricing should not be viewed as a leading indicator of corporate profitability or economic growth.

Finally, it is important to note that the recent correction retraces only about half of the market’s gains over the past year – investors who entered the market in January are still well ahead.

AvSuper’s view and potential implications for members

The relationship between the share market and economy in China is very different to more developed economies. We expect Chinese equity market volatility will have a relatively limited direct impact on Chinese growth and flow-on effects to the global economy. Therefore any major impact on global equity markets are expected to have a limited fundamental basis. The Chinese authorities’ ability to manage this complex and challenging transition will be the most important factor driving the future of Chinese growth.

The risk the Australian economy is exposed to is most directly through the mining investment boom and commodity prices. AvSuper’s positioning over the last few years has included a reduction in exposure to Australian equities and holding a higher exposure to unhedged overseas equities. This positioning has diversified our ‘China’ risk. AvSuper is positioned with a little less in equities overall but favouring unhedged global equities, unlisted assets including core property, infrastructure, credit and private equity. This positioning should provide a reasonable level of protection at the present time.

In summary, AvSuper is continuing to closely monitor market developments and remains cautious about implementing significant transactions.

It is important to remember that this situation is constantly changing and that super is a long term investment. We will update this factsheet as relevant information comes to hand.

Money

 

 

Email: avsinfo@avsuper.com.au  |  Freecall: 1800 805 088  |  Phone: 02 6268 5073  |  www.avsuper.com.au

This information is of a general nature only and does not take into account your personal objectives, situation or needs. Before making a decision about AvSuper, you should consider your own requirements and the relevant Product Disclosure Statement (PDS). For a copy call us or visit the AvSuper website, www.avsuper.com.au. AvSuper Pty Ltd (ABN 46 050 431 797, AFSL 239078) is the Trustee of the AvSuper Fund (ABN 84 421 446 069). FS6121.1 07.2015

 

 

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