After the Fall: The Path Forward for China’s Stock Market and Economy

On October 20, 2015 at its Los Angeles branch, the Federal Reserve Bank of San Francisco hosted an Asia Financial Forum entitled After the Fall: The Path Forward for China’s Stock Market and Economy. The event featured Andy Rothman, who spent 20 years in China first as a diplomat and then as an investment strategist. Rothman is currently at Matthews International Capital Management, LLC and is chiefly responsible for developing research focused on economic and political developments in China. With China’s economy seemingly in turmoil after a sharp fall in the stock market, slowing GDP growth, and weak manufacturing indicators, many analysts argue that the economy is heading for a hard landing. However, at the Forum, Rothman argued that these developments are less important compared to the underlying process of economic rebalancing that is well underway. Rothman stated that consumption and services, driven by steady wage increases, continue to grow strongly and will be the future drivers of Chinese economic growth.

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Key takeaways from the presentation included the following:

• China’s economic growth slowed to 6.9% in the third quarter of 2015, compared to 7% growth in the first two quarters of 2015 and 7.2% growth in the third quarter of 2014. However, Rothman argued that the slowdown in GDP was always inevitable due to demographic changes and the rebalancing of the economy. According to Rothman, the frequently cited 8% GDP growth requirement is somewhat arbitrary and the composition of growth is more important. Moreover, China’s current rate of 6.9% growth is on a base that is approximately 300% larger than it was a decade ago, making the third quarter expansion roughly 60% greater than it was ten years ago. In other words, even though the economy is growing more slowly, the amount of overall production is significantly larger than before.
• Rothman argued that the significance of the recent stock market crash is widely exaggerated. Although the Shanghai Composite Index was down 34% as of October 19th compared to its June 12th peak, the index is up 5% year-to-date, and up 44% year-over-year. The index is actually outperforming the S&P 500 Index on a year-to-date basis (with the S&P down 1.3% as of October 16th) and on a year-over-year basis (with the S&P up 10%). Furthermore, only 7% of the urban population is actively invested in the stock market, with 73% of accounts holding less than USD $15,000.
• Rothman noted that rebalancing is well underway, as services and consumption are now more important than the manufacturing sector, accounting for a 51.4% share of China’s GDP. The real compound annual growth rate of consumption from 2009 to 2014 was 8.7%, compared to 7.2% in India, 5.0% in Hong Kong SAR, and 1.3% in Japan. Consumer spending is backed by significant household savings and steady wage growth, with real per capita disposable income increasing by 7.7% in the first three quarters of 2015.
• Although the industrial sector has exhibited weakening growth (5.7% growth in September 2015, down from 6.1% growth in August 2015 and 8.0% growth in September 2014), the performance of private sector firms is a bright spot. Profits for private firms were up 13% year-over-year in August 2015, compared to state-owned enterprise profits that were down 44% in August 2015. The majority of bank loans are now made to private companies rather than state-owned enterprises.
• Although new home sales and prices have declined, property markets are still holding steady. New home sales were up 21% in July 2015, 16% in August 2015, and 9% in September 2015. Rothman stated that he considers the so-called “ghost cities” to be exaggerated by the media; one main reason for empty housing developments is that units are completed and sold before government infrastructure, such as utilities and public transportation, is put into place. 90% of new homes are owner-occupied and paid for with cash. Developers seem to have learned their lesson about overbuilding new units. As a result there are fewer new housing starts and this has led to slower economic growth.
• Not everything in China is rosy and Rothman noted potential weaknesses to watch out for. Economic decision-making might be becoming too politicized; Rothman questioned whether current leadership will continue to make effective economic policy during a period of slowing economic growth. He also considers the recent intervention during the stock market panic and the devaluation that came from the more flexible exchange rate regime to be policy-making stumbles. Disjointed policy decisions could negatively affect the leadership’s reputation as pragmatic technocrats that have the economy firmly under control. This, in turn, could steer foreign investors away from China and hurt domestic business sentiment.

In conclusion, Rothman argued that economic rebalancing, driven by healthy consumption and wage growth, paints a positive picture of the economic situation in China. The hard landing that many analysts have forecasted is unlikely to come to pass.