The global fixation on Chinese stocks makes no sense, say analysts

An investor checking share prices at a securities firm in Shanghai on Aug 26, 2015.
An investor checking share prices at a securities firm in Shanghai on Aug 26, 2015. PHOTO: AFP

HONG KONG (BLOOMBERG) - From 9.30am to 3pm China time on Wednesday, the three price charts were almost indistinguishable - US stock futures in Chicago, copper in London and the yen in Japan. They were all guided by the same mercurial force: the Shanghai Composite Index.

The benchmark gauge for Chinese stocks, long out of step with the rest of the world, has suddenly turned into a leading indicator for global markets as traders grasp for something - anything - to help them gauge what's in store for the world's second-largest economy.

The problem, according to some of Asia's most experienced money managers, is that Chinese stock prices offer few insights into the country's economic health.

Not only is trading dominated by individual and state-linked investors who pay little attention to economic fundamentals, the Chinese market is also grappling with the fallout from a record unwinding of leveraged bets that had pushed valuations to some of the highest levels worldwide in June. Key measures of the nation's economic growth have slumped to multi-year lows in 2015 despite the Shanghai Composite's 53 per cent surge last year.

"The Chinese market has been highly speculative - a casino," said Hugh Young, who's been investing in Asian equities since 1985 and now helps to oversee about US$478 billion as a Singapore-based fund manager at Aberdeen Asset Management. "It's a convenient thing to hang your headlines on."

MR Young says he has "very little" exposure to the mainland market, though he's been using the China-induced selloff in global shares to look for buying opportunities elsewhere. The Shanghai Composite has tumbled 23 per cent over the past five days, the steepest rout since 1996. The MSCI All-Country World Index has dropped 8 percent over the same period.

As the slump in China's yuan-denominated A shares accelerates, the market's links with global assets are rising. The Shanghai Composite's correlation to both Standard & Poor's 500 Index futures and the yen have climbed to the highest levels on record, according to data compiled by Bloomberg.

"The whole world is looking at the A-share market," said Chen Ruiming, a strategist at Haitong Securities Co. in Shanghai.

Few would argue that the Chinese economy isn't important to world markets. The nation accounted for 38 per cent of global economic growth last year, up from 23 per cent in 2010, according to Morgan Stanley. It's the largest consumer of energy and metals, and the Chinese stock market is the second-biggest after the US. The yuan ranks third behind the dollar and euro in terms of trade finance, according to the International Monetary Fund.

China's equity market has been steadily adding to its ranks of professional money managers. The nine-month-old Shanghai exchange link gives overseas investors unprecedented leeway to buy mainland shares through Hong Kong, and the government plans to replicate the program for the nation's smaller bourse in Shenzhen this year. China has allocated investment quotas of at least US$138 billion through its so-called QFII and RQFII programs for foreign money managers, which include BlackRock Inc. and HSBC Global Asset Management.

Yet China is still a market where individual investors comprise more than 80 per cent of volume on domestic stock exchanges - many of them novice traders who piled into shares at a record pace earlier this year. Until this week, share prices were also getting influenced by an unprecedented government intervention program unleashed at the start of July to prop up the market.

"Investors view the steep decline in the A-share market as an indication of an economic slowdown or economic hard landing in China," said Stephen Corry, who's been following Chinese equity markets since 1994 and is chief investment strategist at the private-bank unit of LGT Group in Hong Kong. "These risks look overstated to us."

The Shanghai Composite's history since trading began in 1990 has been marked by extreme swings. The gauge surged fivefold between the end of 2005 and its peak in October 2007, before tumbling 72 per cent through November 2008. The measure doubled in less than a year from the 2008 low, then lost more than 40 per cent by June 2013.

For most of that time, the Shanghai Composite had few links with major global markets. The average 120-day correlation between the Chinese stock gauge and S&P 500 futures over the past five years is less than 0.1, near the zero level that implies no relationship. The reading is similar for the yen.

"The fact that the stock market has been getting a lot of attention is because the moves are so violent," said Fraser Howie, the co-author of "Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise." "You can't ignore the Chinese economy," said Howie, who first visited the Shanghai Stock Exchange in 1992.

"But the stock market should be for entertainment value, not a daily signal for people to make investment decisions."