It has been quite a start to the New Year. “China-geddon” has taken the mind share of market participants across the globe and Indian investors have been no different. The chaos has been magnified by some prominent investors like George Soros, the well-known hedge fund manager, predicting a repeat of the 2008 financial crisis. As an investor, what should one do in this global din? Let’s look at why markets have reacted negatively.
First, there was a down circuit in the Chinese markets on two consecutive days. The first phase of selling was from local institutions due to lifting of the selling ban imposed by the regulator, quickly followed by others. The global markets also went into a spin, particularly the quant-driven funds as their algorithms busted the risk limits.
The rebalancing of the investment and services sectors over the past five years has led to a slowdown in the Chinese GDP growth from 10.4 per cent in 2010 to 6.9 per cent in 2015. The pumping of excess credit into investments until the last few years resulted in chronic overcapacity. As a result, debt as a percentage of GDP has gone up from 147 per cent in 2007 to 231 per cent in 2015. In order to fund the debt of domestic entities, the government had taken steps to open the equity market to foreigners. As this process was worked on, the local indices zoomed by more than 150-200 per cent in one year. The markets cracked in June 2015 when restrictions to incremental selling were imposed on local institutions.
Meanwhile, the Chinese government was working on its aspiration to internationalise the yuan, by getting it included in the Special Drawing Rights (SDR) of the International Monetary Fund. (IMF). For this, the yuan had to be a truly international currency. With an aim to de-peg itself from the US dollar, the People’s Bank of China depreciated its currency marginally in August 2015. When this was done, communication was weak and it took two days for the markets to know that further depreciation would be against the basket of currencies of its trading partners. The IMF included the yuan in the SDR in October 2015. As the correction in global equities led to fall in currencies, the Chinese yuan had to fall further. Now, this is a catch-22 situation where the partner currencies are falling due to expected weakness of the yuan and the latter is set based on the weak partner currencies.
Commodity collapse
Second, the fall in commodity prices too has affected the markets. This is due to the fear that a Chinese slowdown would hit the demand for commodities as China accounts for a large share of the demand. Additionally, OPEC’s stand on continuing with the current rate of oil production has led to an oil glut crashing the prices.
This has led to some sovereign funds pulling out money from equities, which is leading to the weakness in the markets. Additionally, there are concerns on bank lending to commodity companies. However we do not believe in these doomsday theories. The Chinese have enough levers to manage their economy.
The yuan is still at an all-time high on a trade weighted basis. The People’s Bank of China can cut the reserve requirement ratio further to provide a monetary stimulus and use its reserves of $3.33 trillion if required. Though some traditional measures like electricity consumption and cargo volume put GDP growth at half of current levels, what is positive is the rebalancing towards the services sector. The trends in the real economy are positive as seen in the stable property sales and housing prices.
Indian investors
More importantly, India should matter more for Indian investors. There is no issue of severe competition from China. The lower commodity prices are positive for India. Even if there is a risk-off due to companies or countries going bankrupt, the solutions are themselves self-correcting. In such a situation, the bounce-back can be swift. It is very difficult to predict such an event and its timing. The key is to be invested in strong companies, well-performing funds and not to take leveraged bets. India provides a great opportunity of sustained economic growth and its markets provide a large set of diversified companies to invest in.
As Howard Marks states in his latest memo “On the couch,” market sentiments move from “flawless” to “hopeless” and back like a pendulum. It serves investors best to be balanced in their approach towards the markets.
Mahesh Patil, Co-Chief Investment Officer, Birla Sun Life AMC