Plenty of ink is spilled on the numerical analysis of stock market movements. The more precisely things are stated, or the more beautiful the graphic, the more the illusion may be created that we know what is going to happen, or even understood what did.
But the dominant truth in today’s China is that policy drives everything; and the thinking habits of most of those in charge of policy (not necessarily the same as those who are expert in the markets) are the habits of people who are used to management by fiat.
But in China the objective factors which influence markets and the subjective factors that drive politics are intermingled, making it very difficult to determine the value at which one might reasonably buy or sell.
China is not alone in this. QE in the West is an effort to counteract the effects of governments’ reluctance to spend their way out of the bottom of an economic cycle. Central bank purchases of financial assets in huge volume at low short term yield reduces the cost of borrowing, boosts the value of equities and other capital assets, and thereby (it is hoped) sparks a re-ignition of economic activity. Thus a policy originally conceived to save banks from the consequences of foolish lending into dishonest markets, to preserve the system, morphed into a mechanism to preserve or if possible boost the numerical value of key signals of economic health – stock prices – irrespective of what happened in the underlying economies, and despite the huge damage inflicted on the signalling function of investment asset prices for capital allocation through that price distortion.
So there we have it. Both China and the West are concerned to manage the price signal itself, more than to manage the real-world factors underlying the signal.
In China, the policy aim is two-fold. The primary aim has been to encourage the shift to a more consumer driven economy than the export led or central-investment driven models of old. This is to be achieved by building a wealth effect – by allowing entrepreneurs, businessmen and investors to capitalise on realising the value of all those future cash flows that, until the equity market crystallised them in the present, could not be spent today, but now can be. But it was also to serve as a demonstration, not just to China’s people, but to its leaders and overseas audiences too, that China was back, and a force to be reckoned with.
It is ironic that the vast flood of liquidity, unleashed by China in the aftermath of the GFC to counterbalance the shock of the near-collapse of the Western banking system and the sharp fall in economic activity that followed, should have metamorphosed into a struggle with markets that most of the participants – retail investors, margin-lending brokers, financial analysts, fund managers – cannot honestly claim to understand.
Despite this, the urbanization of China will continue. Thus also the stabilization of incomes, the greater capacity to borrow and the greater marginal capacity to spend that goes with that process. The tide will continue to rise as China frees up her workers to live and work where they will, and employers to move businesses around the country to find the best conditions. But the waves of liquidity and market emotion unleashed and occasionally tamed by government policy will be as unpredictable as ever. In these rough conditions, we need to remember that the tide reflects deeper fundamentals than the waves.
Where does that leave Hong Kong?
Well, on Monday 5th July the Hang Seng Index was initially down 5 per cent, and later settled upwards, for its biggest one-day drop since May 12, 2012, triggered allegedly by the problems in Greece. Such attributions just demonstrate how difficult it has become, now that Hong Kong is more and more exposed to flows of both capital and thinking from mainland China, to keep a sense of analytical rationality in forming a view of how our markets operate.
Play the tide, not the waves.