China 'correction' rattles world
markets By Walter T Molano
The teleprompter readers were gleeful on
Tuesday as the market came to life for the first
time in almost a year. The Dow Jones dropped 416
points, losing 3.3%. The selloff was sharp. The US
equity market lost 300 points in the space of a
few minutes.
Many people were searching
for explanations. Former US Federal Reserve head
Alan Greenspan's comments, US Vice President Dick
Cheney's visit to Asia, the escalating tension
between the United States and Iran and the
deterioration of sub-prime
mortgage providers were
offered as plausible explanatory causes.
However, all the telltale signs pointed to
the 9% selloff of the Shanghai Composite Index.
The major media services were struggling to
understand how a correction in an emerging-market
country such as China could possibly have an
effect on the US. Yet Tuesday's events confirmed
the new reality. Not only do events in China
matter, the Middle Kingdom is now one of the main
drivers of global economic activity and one of the
main barometers of global risk conditions - and
this is very good news for all commodity
producers.
The so-called "meltdown"
occurred in slow motion. The indices gained
momentum as the day wore on, accelerating prior to
the close. Most of the activity was concentrated
in the equity markets. This was not too
surprising, given that the equity markets posted
the largest gains over the course of the past two
years.
The Bovespa (Sao Paulo) lost 6.6%,
the Bolsa (Mexico) dropped 5.8% and the Merval
(Argentina) surrendered 7.5%. The effect on the
fixed-income market was muted, with the exception
of some of the recent corporate bond issues. The
GDP (gross domestic product) warrants also
suffered - losing more than 5%. The GDP warrants,
of course, are high-Beta assets and very
vulnerable to changes in market sentiment.
Investors looked for safety, moving into
Treasuries, gold and short-term assets. Investors
are definitely moving into more defensive
positions, but they should not get overwrought
with fear.
The correction in the Chinese
market was not associated with any fundamental
problems. China's level of economic activity is
sound. Exports are strong. International reserves
are high. The banking system is improving.
Inflation is under control, and the political
environment is stable. So what's the problem?
The problem is that, after lying dormant
for more than five years, the Chinese equity
market went into a tear last year - rising more
than 170% in the space of 14 months. Changes in
regulation, a slew of initial public offerings and
greater wealth accumulation by Chinese retail
investors led to a surge in the Shanghai equity
market - fueling worries among policymakers about
the creation of a speculative bubble.
The
Chinese economic authorities (prudently) issued
warnings at the start of the year that the
speculative frenzy in the equity market was
reaching problematic proportions. Finally, the
monetary authorities threatened that they would
employ drastic measures if equity investors did
not calm down. Tuesday's selloff was the market's
reaction to that threat. However, the selloff did
not reflect concerns about the health of the
Chinese economy.
The over-arching impact
of the Chinese selloff was a clear indication of
China's importance. The rising wealth of China,
and that of its enormous population, brought new
life to commodity producers.
The impact of
the Chinese correction on Latin America was
significant, but muted. Latin America is no longer
a speculative play that depends on global risk
appetites. The region is an exporting powerhouse,
dominating strategic natural resources, generating
enormous levels of international reserves and
developing an immunity system that will reduce its
dependency on global liquidity conditions.
The
BRICs (Brazil, Russia, India and China)
may be falling, but more like a ton of bricks
clattering on the announcement of the new
global economic order.
(Copyright 2007
Walter T Molano, The Emerging Market Adviser.)
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