Perhaps it is the effect of a holiday-shortened week, but everything seems a little lower looking back over the past few days. Starting off, a few days ago some of the major brokerages in China decided to reduce the availability of margin to the trading masses on the mainland. In a market that has historically been retail-driven and rife with momentum, the Shanghai market fell 6.5% in a day. Granted it did not feel like much in a market that was up over 12% in the prior week along, almost 50% for the year, and over 140% for the trailing one year. Of course the question is raised as to whether this will be the end of the bull run in the A-share market. Perhaps…or perhaps it is just a small blip in a notoriously volatile market. As investors in the Emerging Asian Consumer, China included, we watch closely but seek to remember a few things. First, we do not really have much if any exposure to the equities trading on the mainland Chinese exchanges. It is still a closed market for the most part. The Stock Connect done earlier this year linking Shanghai to Hong Kong opened a modest channel which allowed for some momentum to export to the island exchange; therefore we expect some effect but muted. The distinction can best be seen by the valuation difference between the Shanghai market at 20x and the valuation of our China-dedicated active manager estimated around 15x (after the 20% increase quarter-to-date) which is still much lower than the US or European market. Second, the development of an orderly and functioning capital market in China is a good thing for the long-term. Policy makers in China have communicated that they seek market-based mechanisms for capital allocations in the future to avoid the bank-dependent model that evolved in Europe. Cutting back on leveraged speculation might take some wind out of the A-share markets sails, but it should probably have been done anyways.
Staying in Asia, data out of Japan did not look too pretty either. Household spending dropped 1.3% from the year earlier and industrial production was reported lower after the sales tax hike in April 2014 pulled forward demand before the increase leaving a vacuum in its wake. So far, two years of declining currency values have yet a measurably positive impact across the entire economy as spoils fall to the exporters are balanced by the need to import resources onto the stratovolcanic archipelago. The purpose of quantitative easing is not to solve economic malaise, but to buy time to do so. As the central bank balance sheet swells and the expectation is for more, time is running out.
Not to say that the US is immune. The first revision of Q1 GDP was meaningful dropping to -0.7%. The effect of the strong US Dollar was to blame as exports were lower and imports were higher than originally thought. It was estimated that the change in “net exports” reduced overall growth by 1.9% last quarter. That is a considerable amount reflective of the magnitude of change experienced by the currency relative to its trading partners. Prior to the global financial crisis, an economic contraction in the US would be the harbinger of recession. Rarely does the US linger near the flat-line as it typically is either expanding or contracting. Since the financial crisis, the US economy has acted more like an old jalopy. It sputters and whirs now and again, but kicks back in gear and we move down the road. We do not expect this time to be any different.
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