World markets crash, except for China
Far from being the source of risk, China looks like an island of stability
The Shanghai Composite Index rose overnight by 0.73% in the midst of a global equity pullback, while the CSI 300 rose by 0.07%.
Though A-shares rose, H-shares showed modest losses, with the Hang Seng China Enterprises Index down just 0.43%. This compares to losses in excess of 2% in the United States and Japan, and losses of -1.3% for the KOSPI, -1.6% for TAIEX and -0.88% for Sensex. US markets are poised to fall another 1% this morning.
Chinese markets otherwise remain calm. China’s 10-year RMB government bond has traded at a yield of around 3.9% for weeks, untouched by the backup in US and European government bond yields. The benchmark 7-day repo interest rate rose, probably due to higher demand in the advent of the lunar New Year holiday.
This is doubly remarkable considering that Western media have talked about “China risk” as the most pressing danger to the world economy for years. Quite the opposite appears to be the case: China seems like an island of stability. The reason for this probably is no more complicated that valuation and earnings. The forward-looking price earnings ratio of the HSCEI is presently around 8.5 times, less than half that of the S&P 500. To justify the high multiple of the US market, investors must have a high degree of confidence in optimistic earnings forecasts.
As we noted last week, a few high-profile disappointments (Daimler Benz on Wednesday, UPS midday Thursday, Google and Apple on Thursday night) called longer-range profit prognostications into question. Daimler and UPS told the same story: their CapEx requirements would be greater than they anticipated, and earnings growth over the next 12 months somewhat less buoyant than previously projected. In the United States and Europe, the past ten years have been a “capital light” recovery, in which capital expenditures remained extraordinarily low compared to past recoveries. That could not continue forever; at some point corporations will have to spend money to make money. The low-hanging fruit has been consumed, and earnings will be harder to generate in the future, at least in the developed markets.
China’s earnings story is quite independent of this problem. The dynamics are quite different. If, as we conjecture, the present market swoon is driven by earnings more than it is by bond yields, that would explain why Chinese equities are trading in their own universe.