For immediate release: 25 August 2015
Defying Reality and Gravity
Sit tight, don’t panic and think long term - Rowan Dartington Signature’s Guy Stephens on China and
the global stock market crisis
Who would have thought that once the intensity of the Greek debt crisis had faded we would see
the FTSE-100 breach 6,000? Last week we talked about Chinese Whispers. These have now turned
into seriously loud screams of panic with a full blown global equity market correction now in
motion. At times like this, it is important to sit tight and wait for the dust to settle but this may take
a little while in thin August markets with many major players on the beach. It is therefore doubly
important not to panic but to remain mindful of the longer term strategy of investing in assets other
than cash. After all, events in China are not particularly damaging to western domestic economies;
on-the-contrary, they will reduce commodity costs and most likely push out the date when interest
rates will have to rise.
So why the dramatic falls and why now? Doubts about Chinese growth have been building over the
summer with the first evidence provided by the 8.3% fall in Chinese exports recorded in July and
shipments to the European Union and Japan down by over 12%. This has gradually been supported
by weak purchasing managers data and now manufacturing output data, where Friday’s reading
represented the lowest figure for more than six years. During this period, the Chinese authorities
have cut interest rates, introduced liquidity and very recently allowed the currency to devalue,
which did rather smack of desperation at the time, as we commented.
So whilst there is nothing surprising in the data, which is all consistent with an economic slowdown,
the reason why markets are so rattled is that, despite the best efforts of the authorities and
discounting the data manipulation that we suspect goes on, the economy is clearly slowing rapidly
and the second quarter 7% GDP really is pie-in-the-sky going forward. We have known for some
time that ever since the credit crunch in the West hammered global demand for Chinese exports,
the Chinese kept their growth miracle going through massive infrastructure spending projects which
resulted in the construction of airports, roads, underground systems, whole cities and more. This
fuelled demand for commodities, kept the population employed and maintained the growth of the
economy. However, whilst running a centralised and controlled economy, the authorities have a
desire to control everything and have thus far managed the inevitable economic slowdown of an
emerging nation at a measured pace.
But there is only so much real estate, empty office blocks and under-utilised infrastructure you can
build before eventually the misallocation of capital causes a pause so that demand can catch up. A
desire to keep the middle classes content by letting them loose on the stock market was a
fundamental step too far and the attempts to control a mechanism that is driven by greed and fear
have exposed the flaws in trying to combine the free world with a controlled economy. We learnt
this lesson in the UK when we tried to control the value of Sterling against the Deutschmark in the
Exchange Rate Mechanism – this was pivotal as it showed the world that investment markets were
more powerful than any government and that the latter had to respect the former from now
on. This is where we are with interest rates in the West. The Central Banks are terrified of raising
interest rates too soon for fear of instilling panic into markets and triggering recession.
In China, the authorities are not frightened of anything within their own economy and the people do
as they are told. However, when domestic investors lose their shirts playing the stock market, real
estate prices start falling and people lose their jobs as manufacturing falls, accusations of
mismanagement will come with potential unrest and threats to the communist status quo. Whilst it
is very easy to see this as one of those rare buying opportunities for the brave, it is unlikely to be
rectified soon as the communication channels to the markets are non-existent in the case of
China. If this was in the West, there would be statements from the Central Bankers designed to
calm nerves with an explanation of their thinking and understanding of the situation. This is not how
it works in China. They say nothing and simply act, with little justification or explanation which
leaves us all guessing, and they like it that way as you minimise your mistakes.
It is probably a fair prediction that Chinese growth is some way below 7%, just how far below we will
probably never know. However, we can be certain that there will be data releases in the next few
weeks which may defy reality, and whether gravity in the markets has been fully experienced, only
time and history will tell. For the longer term investor, this is undoubtedly an opportunity and we
would recommend investment but, as with any seismic disturbance, there will be aftershocks ahead.
We would therefore advise a staggered approach over time, trying not to get sucked into the
inevitable doom and gloom prognosis we hear around us.