DiligenceChina

Yes, No and Maybe. Glad I could clear that up.

Yes – If the domestic China markets are reacting to FUNDAMENTALS, like a slowdown in demand from overseas buyers and markets (real – not financial), inflation in basic materials embedded deep in the manufacturing supply chain or other systematic threats that manifest themselves in China before they are factored in to other international markets. Not the most likely scenario.

No – If the domestic market is sold off in a panic-driven wave of rumor, emotional impact or loss of confidence. We’ve seen 3 strong sell-offs in the last 4 months and only one of them (at the end of February) MAY have had a knock-on effect on international markets. There will also be a very limited impact if the market is sold-off as a result of new regulations, registration requirements, trading rules, taxes or Chinese financial procedures.

Maybe – If a domestic market sell-off results in a severe correction in the REAL ESTATE market or crimps the ability of domestic Chinese SMEs to fund day-to-day operations. The possibility is that a jolt to the A Share market will reverberate through the Chinese economy and create supply-chain shocks for international sourcers.

The domestic Chinese A Share market is still very insulated from the world financial system. It is a renmenbi denominated system that is dominated by local speculators who do not participate in IPOs (which have a real impact on companies’ ability to finance operations). They are generally taking their own savings - or borrowing against privately owned real estate - to buy secondary shares. Yes, there is some informal buying by HK and overseas Chinese who can skirt local regulations, and a relatively small amount of buying by international institutions. Most of the companies listed on the A share markets are smallish state-directed companies whose initial listing on the bourse relied more on good relationships than good fundamentals. The market is very large in absolute terms, but EVERYTHING in China is large in absolute terms.

Is the market due for a sell-off? Probably. Looks that way to me, and to many others. Will it be painful? If you’re a local worker or small business owner and you thought that paper-profits were real money, then hell yes – it may be devastating to you. But two sets of fences separate the Chinese Bear and Main Street, Earth:

First, a crash in the Chinese equities market will have to have a real impact on the Chinese economy in the medium-term. Not likely. We are talking about a government that has an active policy about CONTROLLING THE WEATHER. They aren’t going to sit back and allow waves of SME bankruptcies to derail their economic planning – or to allow babies and grandmothers to starve on the streets of Shanghai and Beijing.

Second, the renmenbi-denominated A Share market ring-fenced for domestic-only investment will have to exert a systemic impact on international markets trading in Dollars, Euros and Yen. The psychological impact has already been largely discounted – especially after the speedy recover of both local and international markets following Feb 27’s brief apolcalypse. You’ve got to get pretty Rube Goldbergesque to figure out a strong relationship between an A Share correction and international financial markets. The last time I checked, the Yuan was not freely convertible, and China was not short on foreign reserves.

If you are a foreign manager or direct investor and you think the market is going to correct, then factor it into your China planning.

If you’re not, then there are other, more sensible things to worry about. Like those disappearing honey bees.