Strategy: Fresh cracks re-awaken China syndrome

07 Jan 2016


  • Chinese market overreaction has global impact
  • Chinese currency depreciations may trigger foreign policy response
  • Can services sectors hold up when manufacturing is slowing?
  • Disappointing US data should intensify discussion about further rate hikes

At the start of the year, investors often decide to put their money to work and so, this period is typically positive for risky assets. Not this year. A steep decline in Chinese equity markets left its mark on the rest of the world and reminded investors of the risks and sensitivities. The market’s negative reaction to China’s latest manufacturing PMI looks overdone, in our view.


On the first trading day of the year, Chinese markets plunged as a disappointing drop in the Markit manufacturing PMI raised doubts over the view that the economy was stabilising. The services PMIs gave mixed signals, fanning an already lively debate on China’s transformation from a manufacturing and export-led economy to a domestic services-driven one.

This is a gradual process and indeed, the services sector has gained weight in the economy. Investment’s contribution to GDP growth has fallen over time, but this has not been offset by a larger contribution from consumption. We expect this to continue. Monetary and fiscal stimulus should prevent an overly abrupt slowdown. And there are signs of cyclical improvement. Government spending is accelerating; the fiscal deficit will probably widen this year. Home sales have improved and, on average, prices in the 16 largest cities have risen. Car sales and production have shown heathy increases.

However, the equity market plunge was not just related to concerns about the macro economy. The expiry on 8 January of a six-month ban on major shareholders from selling equities could lead to (additional) selling pressure. And the renminbi has fallen rapidly in recent days, raising the risk of (additional) capital outflows. Government intervention in the equity markets has stopped the rout for now. Despite the report on the poor services sector PMI, markets gained on the back of news that the temporary ban on equity sales could be replaced by a structural restriction.


These developments should remind investors of a couple of things.

  • Firstly, Chinese equities are volatile and the authorities often struggle to accept this and let market forces do their work.
  • Secondly, the outlook is mixed for the Chinese economy, with cyclical stability in the near term and structural challenges thereafter.
  • Thirdly, China matters to the rest of the world. The market plunge caused shockwaves in the US, Europe, Japan and emerging countries.
  • Finally, the steep fall of the Chinese currency is negative for Japan, South Korea and other Asian economies and could trigger policy reactions, especially in Japan, where a stronger yen could cause the central bank to step up the pace of quantitative easing, even as government pressure on the Bank of Japan to stimulate the economy has abated.


With virtually all manufacturing PMIs now released, our global GDP-weighted average fell to its lowest in 2.5 years. Recent weakness has come from Canada and the US. The eurozone manufacturing sector has done better due to the weaker euro. In Japan, the PMI has held up well, but we have seen weakness in China, Hong Kong, India and Indonesia.

PMIs have improved in South Korea and Taiwan despite weak industrial production and exports in both countries. Overall, the average manufacturing PMI was down in industrialised countries and unchanged for the third straight month in emerging economies.

Data on the services sector PMIs released so far bears watching with falls in the US, France, Australia, Russia and China. Economic surprise indicators, measuring how the data stands up to expectations, have turned down in the US and Europe. They have held up better in Japan and emerging markets. Our proprietary nowcasting index points to modest growth in the US in the fourth quarter amid the ongoing drawdown in inventories and a slowdown in consumption growth, while the drag from trade may have intensified. Such disappointing data could encourage policymakers at the US Federal Reserve to lower their interest-rate forecasts and intensify the debate over whether December’s fed funds hike was a mistake.


Reflecting the rocky start to the year, the VIX volatility index spiked to above the levels seen in the first half of last year. Next to the news from China and disappointing data elsewhere, increased tensions in the Middle East may have played a role. We think the Iran-Saudi conflict could lead to increased output, adding to pressure on prices. We are neutral on commodities, noting that broad commodity indices have held up better than oil.

High-yield corporate bonds suffered in the rout as spreads widened, but government bonds this time performed their safe-haven role, as they often have in the past.

We have taken profits on our underweight in emerging equities after markets fell to their August and September lows and are now better discounting our cautious view.

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