Sometimes, it seems like financial markets can only focus on one big issue at a time. For much of last year,
markets were mainly worried about the broad-based economic slowdown in China, which was a result of policymakers’ efforts to slowly wean the economy off its debt dependence.
This hit emerging
Asia equity markets hard, and they fell by more than 20 per cent in the first half of 2018. Then, towards the end of the year, markets turned their attention to worries about slowing growth and rising
interest rates in the US economy. This drove a ferocious sell-off in global developed market equities. During this time, emerging and Asian equities actually outperformed most other regions, as worries about the Chinese economy faded somewhat into the background.
Since the turn of the year, some calm has returned to developed equity markets and the focus of worries has once again shifted back to
China. Recent economic news from China has been disappointing to markets in terms of both hard data and sentiment. The weakness is likely to continue for the next few months due to tariff shocks and a probable
property market downturn.
One key issue is that despite the
trade war with the US, China’s exports held up relatively well as exporters front-loaded their shipments to the US to get ahead of expected further increases in tariffs. As inventory levels build up, this front-loading will have to taper and reverse in early 2019, even if a US-China trade deal is reached.
This was probably a big reason behind the recent weak Chinese export data. This does not just concern China itself: its close Asian neighbours, such as
South Korea and
Taiwan, are also likely to feel the spillover effects and there are already early signs of the Asian export cycle rolling over.
In the face of these headwinds, Chinese policymakers are sure to add more stimulus measures and policy easing. Since the start of this year, they have already
substantially eased reserve requirements for Chinese banks, to boost lending, and promised
more tax cuts. More monetary, fiscal and property easing measures are very likely to follow in due course.
The question is what impact that might have on markets. Looking at China’s last three easing cycles, in 2008, 2011-12 and 2014-2016, there is no simple relationship between stimulus measures and market performance. That said, unsurprisingly, equity markets generally react more positively the bigger the government stimulus is. The huge stimulus in 2008-09, for instance, provoked an equally big rally in Chinese and emerging market equities.
But, at other times, markets have a tendency to become overexcited and rally too early, only to then react with disappointment and drop when policy stimulus takes more time to work than hoped. And, compared to previous episodes, the current policy-easing cycle has been decidedly on the smaller end of the scale.
It is likely to remain so, given that policymakers are worried about already-high debt levels in China and wary of their efforts potentially resulting in reinflating a property bubble. Even if “trade peace” were to break out soon, it would probably be a mixed blessing for the markets at first, as policymakers are likely to see it as an opportunity to cut back on the amount of stimulus.
Putting all the above together, it looks like it will take at least until the second half of this year for growth in China to stabilise, and economic data is likely to get worse before it gets better. Given the nervous state of financial markets, until then, it could be wise to treat any overexuberance in Chinese and emerging market equities with a healthy dose of scepticism.
Patrik Schowitz is a global multi-asset strategist at JP Morgan Asset Management
This article appeared in the South China Morning Post print edition as: Beware of market exuberance in China and emerging economies
