Could Donald Trump Trigger a China Stock Market Crash?
World stock markets boomed in 2016, on the back of easy credit and renewed signs of growth-led inflation. The markets climbed every wall of worry imaginable: terrorism, Trump’s November election victory, Brexit, and more. Yet, the Shanghai Stock Exchange (SSE) lost ground in this euphoric atmosphere. With serious trade and debt issues looming, the poor performance of the SSE could be foreshadowing a China stock market crash.
Let’s begin with the performance of several leading world equity exchanges in 2016. Russia Micex Index gained 28.6%; Argentina’s Merval Index surged 45%; Brazil’s Bovespa Index rallied 39%; Canada’s Toronto Stock Exchange rose 17.5%. Markets in Germany, Norway, U.K., and Indonesia all gained significant ground. One of the tamer major exchanges, the S&P 500, still gained 11.5% in 2016, and is off to a torrid start in 2017. The SSE however, lost 8.19% and finished as the major equity exchange outlier in 2016. This occurred despite the yuan losing about 6.17% on the year.
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What’s Going on with China’s Stock Market and Economy?
So, what’s going on with China’s stock market and economy to warrant such a dismal performance? In short, stalling China economic growth and rising protectionism throughout the world, which have hampered Chinese exports.
Speaking of the growth in gross domestic product (GDP) in China, it’s actually quite strong by western standards. The China GDP growth rate averaged approximately 6.7% in 2016, well above the United States’s sub-two-percent levels and most European nations. The problem is that growth is simply not good enough for the still-developing communist nation. This may as well be a Chinese recession at that rate. Lack of robust job growth means a lack of job growth in the nation of 1.6 billion, posing an enormous problem for the communist government.
Unfortunately, growth is likely to get worse for the foreseeable future, at least until China is able to transition its export-based economy to an internally-based one. This won’t be easy in a country where the Gross National Income averages under USD$15,000 (2015 numbers).
Chinese President Xi Jinping has signaled as much. Late in 2016, Xi told a meeting of Communist Party officials that China doesn’t need to be wedded to its official 6.5% GDP growth policy if doing so created too much risk. (Source: “President Xi Open to Growth in China Falling Below 6.5%,” Bloomberg, December 23, 2016.)
This was particularly significant on a couple of levels.
Firstly, since China had stubbornly persisted in meeting growth targets in the past, a move off this policy is significant. While much necessary public infrastructure has been built over the past 20 years, an enormous amount of credit misallocation has gone towards building unproductive structures. China’s GDP targets have been met through legitimate and illegitimate capital expenditures (CAPEX) alike. Without the latter, such as the famous “cities to nowhere” or the detonation of new buildings to make way for even newer ones, there’s no way China can meet its growth objectives. By moving off its 6.5% official growth target, President Xi may be signaling China no longer has the appetite to supply unlimited credit for such unproductive purposes.
Indeed, China’s been on a construction tear for years. As The Washington Post reports, between 2011-2013, China consumed more concrete in this three-year period than the United States consumed in the entire 20th century (Source: “How China used more cement in 3 years than the U.S. did in the entire 20th century,” The Washington Post, March 24, 2015.)
Just let that sink in for a second. Sure, China has a much larger population than the U.S., perhaps requiring more infrastructure, but the levels of consumption are just mind blowing. We’re also not even talking about the beginning of the transformation of a nation. China first started its “Great Modernization” in the 1980s. It doesn’t take a PhD in economics to understand much of this construction boom is simply being shoveled into wasteful projects to conform to government mandated growth objectives.
Judging by more recent numbers, the misallocation of Chinese construction projects may have jumped the shark. In 2016, China completed the construction of more skyscrapers than the rest of the world combined. China completed the building of 85 skyscrapers; in second place, the U.S with a grand total of seven. (Source: “This Won’t End Well – China Skyscraper Edition,” Zero Hedge, January 31, 2017.)
It’s undeniable how much the construction boom has contributed to Chinese growth. Once the inevitable slowdown occurs, this could have a major negative impact on the Chinese economy.
Secondly, China may now be accepting the fact that growth in exports may have peaked, and will simply let nature take its course. The decrease in exports in 2014 (see chart below) has come despite the yuan losing 13.55% of its value since 2014. With the possibility of a trade war with the Unites States looming, at minimum, China can expect slightly weaker export dynamics going forward. At worst, sizable tariffs with the U.S. could cripple its manufacturing exporting base.
There’s nothing the Chinese government can do to significantly boost exports at this point. The low hanging fruit of globalization has already been plucked. The maturation of the Chinese economy has boosted wages to where now, labor arbitrage is occurring elsewhere. It’s simply cheaper to set up shop in places like Vietnam and Indonesia, where labor costs are even lower.
Furthermore, the benefits of globalization are actually reversing. Because robotics and automation are replacing manufacturing jobs en-masse, multinational companies are starting to reinvest in nations that purchase their products. Why pay 1000 factory workers in China to exports goods back to developed nations, when you can build a high-yield factory in North America or western Europe with 100 people? Not only do companies have much tighter supply chain dynamics, freight and political risk considerations are much lower.
In short, while exporting is not dead, China’s exports and a percentage of GDP has peaked and will continue to trend lower. China realizes the need to boost internal demand, but getting there won’t be easy.
Will China Stock Market Crash in 2017?
Dismal recent performance aside, the possibility of a China stock market crash exists if certain factors develop. A nasty trade war with the U.S. would be one such component, while a credit slowdown halting capital expenditure growth would be another. Both have fairly good odds of transpiring in 2017.
In terms of the latter, Donald Trump has publicly threatened the imposition of 35% tariffs on imported goods. As the U.S.-China trade deficit is hovering around $350.0 billion annually, China would be majorly impacted by such actions. An increasingly competitive landscape would be made immeasurably harder if the Chinese were priced out of its biggest export market. China would undoubtedly take retaliatory measures, but those would aim to weaken the U.S. more than they would help their domestic economy. The stock markets would take a direct hit under such conditions.
| Month | Exports | Imports | Balance |
|---|---|---|---|
| January 2016 | 8,212.1 | 37,145.7 | -28,933.5 |
| February 2016 | 8,048.7 | 36,160.8 | -28,112.1 |
| March 2016 | 8,952.3 | 29,852.7 | -20,900.5 |
| April 2016 | 8,667.1 | 32,973.2 | -24,306.1 |
| May 2016 | 8,518.3 | 37,535.2 | -29,016.9 |
| June 2016 | 8,822.7 | 38,579.0 | -29,756.3 |
| July 2016 | 9,156.9 | 39,487.1 | -30,330.2 |
| August 2016 | 9,393.9 | 43,247.3 | -33,853.4 |
| September 2016 | 9,559.9 | 42,022.7 | -32,462.8 |
| October 2016 | 12,698.0 | 43,807.1 | -31,109.1 |
| November 2016 | 12,119.3 | 42,620.5 | -30,501.2 |
| December 2016 | 11,626.0 | 39,381.8 | -27,755.8 |
| TOTAL 2016 | 115,775.1 | 462,813.0 | -347,037.9 |
2016: U.S. trade in goods with China (Source: “Trade in Good with China,” United States Census Bureau, last accessed, February 21, 2017.)
It hasn’t helped that Secretary of State, Rex Tillerson, has rattled sabers early on. Tillerson said Beijing’s island-building in the South China Sea was illegal and “akin to Russia’s taking of Crimea.” He further vowed his intentions to halt reef island construction and restrict China’s “access to those islands.” Keep in mind, about $5.0 trillion in annual trade passes through the South China sea corridor. (Source: “Chinese Media Has Told Rex Tillerson to ‘Prepare for a Military Clash’,” Time, January 12, 2017.)
With the bad blood spilling over early, it’s anybody’s guess how this turns out. Trump has repeatedly labelled China as a currency manipulator, and with his cavalier attitudes, it’s unclear whether Donald Trump would adhere to favorable Chinese World Trade Organization (WTO) on trade. This uncertainty is likely to weigh on the SSE until more clarity arises.
In terms of credit growth, this too remains a great uncertainty. I’ve already discussed how rampant CAPEX spending has artificially boosted growth for many years. It’s bubble finance gone mad, but it may be slowing down shortly.
Moody’s rating agency started the ball rolling in March 2016, lowering China’s credit rating from “stable” to “negative.” They cited several factors, ranging from uncertainty about needed economic reforms to a weakening of fiscal metrics. (Source: “Moody’s lowers outlook on China’s credit rating to negative from stable,” CNBC, March 1, 2016.)
Chinese corporate debt also remains staggeringly high at about 145% GDP. The large state-owner enterprises that are at the heart of the credit binge are increasingly having trouble servicing debt payments. Default ratios have been on the upswing and the International Monetary Fund (IMF) estimates 15.5% of commercial bank loans (about $1.3 trillion) is at risk. (Source: “China’s Growing Debt: Are The Fault Lines Beginning To Show?,” Wharton University of Pennsylvania, June 6, 2016.)
While a Chinese stock market crash didn’t occur in 2016, a small scale version of the China stock market crash of 2015 is possible. After a 160% increase in SSE prices from June 2014 to June 2015, the wheels fell off quickly. In less than three months, the SSE lost nearly half its value and has been in stall mode ever since. Just like that, the China miracle turned into a nightmare.
In the end, what the Donald Trump presidency could mean for China is uncertain. But regardless of the ebb and flow of relations with the U.S., interested readers should be wondering, if the China stock market outlook is so great, why does China continue to experience record capital outflows? Why are investors so determined to offshore their money outside the homeland? The reason is what you think: investors are not optimistic about China’s economy.
Is the Chinese Stock Market Crashing?
Ultimately, the question of whether a SSE crash will happen in 2017 depends on how the political landscape and possible credit contractions play out. Even China bulls (count me among them) will concede that the transition to becoming a more insular, self-reliant economy will be a protracted affair.
