China's changing market fortunes
Summary: Interesting times ahead for the Chinese economy.
Key take-out: A potential downturn in China will have implications for us.
Like most commentators and investors, I always keep an eye on the Shanghai Index.
But, in recent times, it has become one of the first things I look at each day because China has become a global danger spot. Given that Australia is incredibly closely tied to China, we have a strong interest in what is taking place in the Middle Kingdom.
That's why on Tuesday afternoon this week, I was on the edge of my seat.
During the previous week, the Shanghai Index had chalked up a 20 per cent fall from its peak, which is a major reverse by any standards.
Stock market falls of this magnitude often have a severe impact on the total economy. Most people in Australia assume that when there is a crisis in China, the authorities will take control and the economy will continue to grow. Accordingly, the Shanghai Index recovered 2 per cent at the end of last week. Over the weekend, it was widely suggested that the Chinese authorities would step in to bring the stock market under control and manage the problems in the way they always have.
But in the first two days this week, the market fell again and by Tuesday afternoon the Shanghai Index was once again faltering, the yuan had plummeted to its lowest level for just under a year and, in turn, the Australian dollar was also crumbling. Then, “Wham!” – someone high up in the Chinese Government issued a buying directive and the Shanghai Index surged to end the day in positive territory and the yuan (and the Australian dollar) surged.
But a lot more than market support will be required by the authorities. Australia has been affected by the problems in China, with the reduction in Chinese buying a major factor in the 20 per cent fall in the prices of inner city one and two bedroom apartments in Sydney, Melbourne and Brisbane.
Moreover, the giant Chinese HNA group – which last November made an unsolicited $400 million bid for the refrigerated logistics business of our largest automotive dealer Automotive Holdings Group – suddenly withdrew its bid.
HNA is of course a major shareholder in Virgin Airlines. Most of the commentary focused on the fact that relations between Australia and China have cooled, and these tougher relations were blamed for the Chinese withdrawal. That may be partly true, but to me it looks like HNA is suddenly becoming more cautious.
The Shanghai Index is supported by investors who have borrowed around $US1 trillion in margin deals. This fall in the market will therefore create huge losses for many people. At the same time, tighter banking controls in China have forced banks to reveal a whole series of dodgy loans that had been concealed in off-balance-sheet vehicles. That is not a pleasant experience for any banker and has contributed to the tightening of credit. Anti-corruption has also become much more stringent.
President Trump has imposed tariffs on Chinese exports and China has responded with its own tariffs or restrictions on US goods. The fall in the Chinese currency helps China overcome the tariffs' impact on its exports to the US, but its costs for raw materials, such as iron ore, oil and a wide range of componentry, have jumped sharply.
Adding salt to these wounds is the fact many large Chinese companies borrowed in US dollars to take advantage of lower US interest rates. If they had offsetting US income, the companies were fine, but many did not and will now be suffering badly.
These factors have helped to bring down the Shanghai Index and are now causing Hong Kong, which deals with international Chinese shares, to be affected. In the past, China has always managed to get itself out of trouble. It would be a big call to say that it will fail this time and I certainly would not make that call. However, there are clearly warning signs of danger ahead, which we need to monitor.
Brexit sticking points cloud UK shares
On the subject of international markets, I was holidaying in the UK and Norway. Most of my UK travels were in Scotland but I did get a real sense of nervousness about Brexit. The UK government is finding it very difficult to coherently make decisions on Brexit and there is a real chance of a costly shemozzle.
To illustrate that business is reaching breaking point the British Chambers of Commerce (BCC) released a list of 24 questions this week that companies are asking about Brexit.
Director general of the BCC Adam Marshall says, "Business patience is reaching breaking point”.
The chamber says that companies are unsure of whether they'll face new regulations, tariffs or customs checks. It's also unclear if they'll be able to move staff between the European Union and the UK or be forced to pay new taxes.
One simple question is, "Will my business have to pay mobile roaming charges in the European Union after Brexit?".
More than two years have passed since the UK voted to leave the European Union, but Prime Minister Theresa May's government has not been able to settle key issues within its own ranks, let alone with its EU partners.
The two biggest sticking points are how to avoid customs checks for goods moving between Britain and the European Union, and how to handle the border between Northern Ireland (part of Britain) and Ireland (part of the European Union).
Obviously selected companies may be attractive, but I would be very careful buying British shares – you will need to be investing in a particular company presenting a wonderful opportunity.