A three-week, 30 percent slide in the world’s second-biggest equity market has had only a glancing effect on emerging market portfolios still light on China’s Shanghai stocks, but the economic fallout from the shakeout poses a bigger risk.
Almost $3 trillion has been wiped off the A-shares listed in Shanghai and Shenzen since mid-June, despite increasingly frantic counter-measures. On Monday, an opening 8 percent bounce after a fresh liquidity addition gradually faded, with shares closing only 2 percent higher.
The moves are on global fund managers’ radar. Big falls on Monday on Chinese depositary receipts (ADRs) listed in the United States hint at a further reverberations. . But with foreigners’ A-share exposure still miniscule, portfolios are so far largely unscathed.
“To the extent that the A-share market offers limited access to foreigners, the impact on global portfolios too has been limited,” said Jorge Mariscal, chief investment officer for emerging markets at UBS Wealth Management, which manages $1 trillion of client money but holds no A-shares.
The main reason is that A-shares are not included in the main indexes. Instead, foreigners invest via investment quotas and more recently, a stock connect system that gives more offshore investors direct access to Shanghai shares.
Based on foreign take-up of investment quotas and flows generated by the stock connect, no more than 2 percent of the Shanghai-Shenzen market capitalisation is owned by non-residents, says Karine Hirn, a Hong Kong-based partner at East Capital. Some 85 percent of transactions are conducted by China’s army of mom-and-pop investors.
“There’s been a lot of talk about opening up the A-share market but let’s face it, it’s still very limited,” Hirn said. Her firm has held Chinese investment quotas since 2013 but has less than 5 percent of its total assets in that market.
The recent falls also came after Shanghai shares climbed 150 percent in the year to June, outperforming all other emerging and developed markets. Markets in fellow BRIC states – whom Beijing meets in summit this week – lagged significantly in this period
A-shares have displayed little correlation with Asian, emerging and global peers – since mid-June emerging equities are down 4 percent and MSCI’s main China index has lost 8 percent.
Much of the move up was driven by a huge increase in margin lending – borrowing to invest – as locals bet on interest rate cuts and tried to front-run an anticipated foreign influx.
But foreign investors, better-versed in the ways of markets, were pulling cash out well before the latest rout. Between January and May, China-dedicated funds, which buy both mainland and offshore-listed stocks, shed $18 billion, according to EPFR Global.
“Price-earnings ratios went off the wall and were clearly moving into bubble territory,” said Jan Dehn, head of research at Ashmore, which sold just before the market peaked.
As Dehn points out, anyone buying A-shares a year ago would still be up 70 percent. But many of the small-time Chinese buyers would have joined the party just as it was winding down.
More than 30 million new individual stock accounts were opened between end-March and mid-June, BNP Paribas notes. What’s more, margin purchase deals, believed to account for almost 5 percent of tradable market capitalisation, may be much larger because of other, unofficial, borrowing channels, BNP said.
“Their holders are now, on average, under water. This means that consumer wealth and confidence have been reduced, and so will the growth of their spending,” the bank said.
It reckons this year’s stable retail sales were helped by equity gains but warned that “negative wealth effects resulting from the recent bear market will likely slow the consumer.”
Therein lies the problem. Chinese growth may fall under 7 percent this year. With exports lacklustre, any drop in consumption or rise in bad loans will hurt profits at banks and companies that are listed not just locally but also in Hong Kong or New York.
And with China comprising a fifth of emerging equity indexes, portfolios could suffer losses later. Unchecked, they may trigger an exodus from other emerging markets, too.
“The overall wealth effect is still positive, but if this continues it may affect investment, consumption and the pace of structural reform,” Mariscal said.
Already, by tinkering with regulation and monetary policy to temper market moves, Beijing is seen to be backsliding on financial system reforms.
Hirn of East Capital downplays the wider risks of declining consumption, because securities investments comprise 6 percent of Chinese households’ balance sheet versus 17 percent in the United States. Cash accounts for 26 percent. The eventual inclusion of A-shares in major indexes will also offer support, she said.
“It’s been a massive cold shower for people,” Hirn said. “But if they manage to stabilise the market and it’s 20-25 percent cheaper, there will be people moving in.”