Wealthy Nations Daily Update - China Equities and Rate Cut.

The boom in Chinese equities which ran for the last half of 2014 and the first half of this year moved the Shanghai Composite Index from 2k to 5k at an alarming pace. Following the past 2 months of drawdown and the 15.5% crash of the past 2 days the index has now dipped back below 3k; meaning ‘only’ a 50% return since mid-2014 as opposed to the 150% return had investors cashed out mid-June. Unlike yesterday, the wider reaction to China’s further losses were mostly sanguine with Europe and US markets retracing most of yesterday’s panic losses, however the Japanese major equity indices were off a further 3-4%.

The factors affecting yesterday’s 8.5% loss on the Shanghai Composite along with today’s 7.6% fall may however prove to be a positive development for the market and not just because it has brought some equity valuations back from stratospheric levels (though probably still not into value territory). Part of the move is a reaction to the Chinese government moving away from their market support policies and interventions and more towards better regulatory oversight. Whilst such levels of intervention persist there will of course be investors that are seduced by this absolved risk (such as through the daily 10% limit down) paired with such stellar recent returns. But with both under question the rout of speculators may continue as the past two days has seen this limit hit for the majority of stocks in the index.

Moreover, out of determination to meet their 7% growth target, China cut interest rates by 25bp as well as the reserve requirement ratio by 50bp. All this could be a positive development if it becomes clear that China is serious about becoming a not-so-crony market economy. This interest rate cut is a more favourable remedy to the recent rout than the interventionist trading suspensions and the about-turn on restricting margin trading. This pain is part and parcel of the bumpy transition away from state controlled FX and stock markets. Chinese officials must continue to fight the seductive habit of short-term interventions and allow these ‘disappointments’ to increase accountability and market forces in their economy. In the long run this will be the best way to promote growth at a sustainable rate. With all the recent developments and official statements it is clear that such liberalisation is indeed a major goal of the Chinese authorities. But managing expectations of competing goals, such as growth targets and exceptionally low volatility, will continue to be a political challenge.