Can a falling China mean India shining?
The crash in China’s stock market, which wiped out an estimated four trillion dollars of wealth, and the overall slowdown in the Chinese economy have begun to worry global investors. The effects have begun to be far-reaching, underlining the reach of the world’s second-largest economy, effecting everything from the strength of currencies to commodity prices across the world. How do leading global investors make sense of the troubles in China and look at the future of its economy? Chris Solarz, Managing Director at American hedge fund Cliffwater, closely follows Asian markets in his role researching global markets for the fund. In an interview with India Today, he says that with the troubles in China, India is the “most bullish feel good story in Asia” on Wall Street at the moment: How have the recent stock market troubles in China been seen on Wall Street? Did the extent of the crash come as a surprise, or was there an expectation that a correction was due?
The stock market saw a strong rally until June 12. What is really interesting is that the 30 to 40 per cent sell-off is just the flip side of the extraordinary gains we saw since last year, but it was only the downward momentum that grabbed headlines. We didn’t see articles saying the market was up 100 per cent but down 30 per cent, and it is still up around 70 per cent.
One thing that’s really interesting is the misconception that the economic rise of a country will be correlated to stock market gains. If you look at the 10 year period ending mid-2014, you would see a huge disconnect between China's GDP growth and annualized stock market returns. When the market started going up in 2014, it was the result of Chinese citizens making stock investments with borrowed money rather than accelerated growth of the economy, which was in fact slowing at the time. In April or May, I saw charts that blew my mind that Chinese tech stocks’ P/E ratios were 50 per cent higher than the P/E ratios at the apex of the Nasdaq bubble. These numbers were off the charts.
Another interesting corollary to this story has been the commodity market rout. Since the Chinese equity market peaked on June 12, the US dollar is up considerably, which has led to the sharp sell-off in commodities. Specifically, commodities related to China and currencies related to China, including the Canadian dollar, Australian dollar, New Zealand dollar, Korean Won, Thai Baht and Malaysian Ringgit, are down versus the US dollar, as the US dollar has strengthened a lot in the past month. That is one of the biggest developments seen from my perspective.
Do the opacity of the Chinese economy and questions about the data put investors off? And have the recent events in the stock market changed how you look at China in the long run?
Of all of the hedge fund managers I talk to, nobody believes the numbers that come out of China and we take official figures with a grain of salt. There's heavy skepticism not just for China but every developing country. When hedge fund investors go to China, some visit companies without a translator and they can't talk to employees. There are plenty of rumours that companies are stacking offices with people who don’t work there. One of due diligence questions is people ask for monthly statements of electricity use.
From our clients perspective it hasn’t been a big deal. China lost four trillion which is 15 times the Greek GDP. We are focused on the wrong thing - we are focused on political dynamics in southern Europe! You’re losing four trillion of value in the other side of world yet questions we received very much focused on Europe. This is partly because the Chinese economy is simply not open for international investment the way Europe is.
Do you expect that lack of openness to change going forward?
I think slowly but surely it is inevitable that change will continue and investments will be greater. It is very rare for any US hedge funds to have large exposures there today. However, a main focus of the current administration is to continue to liberalize the financial markets, and coupled with the largest up-and-coming consumer middle class in the world, this will ultimately lead to a compelling bullish mantra.
If you look from any perspective, GDP or population, all equity indices in the world underweight China. If you just bring this up to fair allocation, there will be trillions of inflow into Chinese stock markets. These things are very slow but will happen. It is inevitable there will be walls of money flowing into Chinese equities as part of index diversification but these events do give people a bit of a pause.
Will the fall in China be to India’s advantage?
It is unanimous across managers that I speak to that India is a bullish feel good story at the moment. Some people call it "the Modi trade". The simple story is starting from last year right before the Modi government came in and won a super majority you had all these stories about deregulation and liberalisation. Of course there are going to be ups and downs though. Nothing goes up in a 45 degree line.
If you ask most of the guys we speak to, India might be the most bullish country in Asia. To be honest a lot of other Southeast Asian currencies and economies are thought of in my perspective as a derivative play on China. Korea, Thailand, and Malaysia are leveraged to China based on proximity and any Chinese slowdown will simply trump any of the up and downs in that country.
The Chinese slowdown will have a huge impact on commodity prices as well. For the past 20 years, China became the major global market for most industrial commodities, buying more than half of all margin demand in a number of commodities. These commodities were used to building the country’s infrastructure but much went into stockpile as well. This sell-off in Chinese equities and slowdown in Chinese growth can very well lead to a liquidation of these stockpilings, which has already occurred over the past few months. Oil is down 20 per cent. There is a realisation that China is not going to be growing the way it was.
Have these events changed how you look at China in the long term?
China has done an amazing job of leading global growth these past five years at a time when the world really needed some growth. This is part of the global economic cycle.
China, like India, has about 30 subdivisions. Amazingly each of those is much larger than most European countries. We talk about Sweden or Spain but not all of these different areas. We talk about India or China as a unit but that is misleading. It is true that there are ghost cities in China where they've replicated the Eiffel Tower and actual sized Manhattan buildings and these cities are completely deserted. Some say that if that’s true, China will fall apart. Yes, that town or province may fall apart, but you have 1.3 billion people and a rising middle class that will increase consumption and slowly become richer. This story I think is still a very powerful one.