The ‘Great Fall of China’ and your savings

Why were markets so spooked?

China is seen as the world’s growth engine and its consumption of raw materials, energy and consumer goods are of huge importance around the globe. Jason Hollands, managing director of Tilney Bestinvest, says: “A rapidly slowing Chinese economy affects us all because since the global financial crisis broke in 2008, Chinese economic expansion has contributed over 50 per cent of all world growth and asset markets are incredibly interconnected. The effects of the slowdown in China and lancing of its equity bubble could be felt in all sorts of places, including the London property market.” China’s economy expanded at its slowest pace in 24 years in 2014, and a recent spate of weak data, including an 8.3 per cent fall in Chinese exports recorded in July, raised concerns about the health of the world’s second-largest economy, which has struggled to achieve the state-set target of 7 per cent GDP growth. This came on top of the fact that two weeks ago China devalued the yuan, prompting fears that other nations would embark on a currency war in a tit-for-tat bid to maintain their competitiveness. When the Chinese market sneezed, the world caught a cold.

Is it a bubble?

Despite the worsening economic picture China’s 200 million retail investors have been encouraged to pump billions into the stock market and more than 30 million new trading accounts were created in the first five months of 2015 alone. Much of this explosive growth has been fuelled by margin lending, where brokerages loan money to investors to play the markets. Over 12 months stocks soared by 150 per cent, but then the mood changed. Rob Donaldson, head of M&A and private equity at Baker Tilly Corporate Finance, says: “Investors being encouraged by the state apparatus to plough their money into shares pushed prices up far beyond their fundamental value and what we are now seeing is a painful, but perhaps necessary, return of common sense.”

So what changed?

In June a huge 30 per cent fall caused panic. Whereas most other stock markets are dominated by institutional investors, in China 80 per cent are small retail investors so a market crash would have serious repercussions for the government. It intervened quickly to restore confidence and allowed half of China’s listed companies to halt trading, provided more than $480 billion for brokerages to buy shares, froze new initial public offerings and lowered interest rates. It even encouraged retail investors to literally bet the house on the market by allowing homes to be used as collateral for margin lending. The moves weren’t enough to prevent a selling stampede, however, and this finally spread to other markets on Monday. Guy Stephens of Rowan Dartington, the wealth management company, says: “A desire to keep the middle classes content by letting them loose on the stock market was a fundamental step too far and the attempts to control a mechanism that is driven by greed and fear have exposed the flaws in trying to combine the free world with a controlled economy ... Chinese whispers turned into seriously loud screams of panic.”

Should I be worried?

Some analysts see the measures that China has taken recently to be signs of increasing desperation - the sentiment that sparked this week’s events - but others believe that they are consistent with a planned transition from an unsustainable export-driven economy to one that is driven by domestic consumption. Andrew Parry, head of equities at Hermes Investment Management, says: “Commentators are divided between viewing this as part of a panicked reaction to weakening demand and those, including us, who see it as part of the long-term and well-flagged structural reform of the Chinese economy.”

What does it mean for the market?

According to Simon Marsh, a partner at Killik & Co, equity market corrections of 10 per cent are not unusual in bull markets. He says: ”A similar pull-back in July 2011 proved to be nothing more than a short term setback and a good buying opportunity. This current bout of nervousness feels very similar. We should expect some heightened volatility over the next few months, but this doesn’t yet feel like the start of a more significant sell-off of the type seen with the bursting of the tech bubble in 2000, or the sub-prime crisis of 2007.” David Stubbs, global market strategist at J.P. Morgan Asset Management, also believes that investors should put the recent volatility in context. He says: “Over the last 35 years, markets have typically on average experienced a 16 per cent intra-year decline; however, in 27 of the last 35 years, the markets then rallied to finish up on the year. This sell-off is roughly in line with previous historical sell-offs.”

So should I sit tight?

The first thing to do is make sure that you are protected from growing volatility by not having all your eggs in one basket. Nigel Green, chief executive of deVere Group, says that investors should ensure that their portfolios are diversified by geography, sector and asset class, rather than sell in a hurry. “In terms of what investors should do,” he says, “it is not ‘sell in a panic’, or the opposite reaction: ‘fill your boots with bargains’. For most long-term investors, it is ‘keep calm and carry on’. Panic-selling in stock market crashes can be potentially financially disastrous for investors.”

...or snap up some bargains?

Prices have fallen, but it’s impossible to predict the bottom of a market so a gradual approach is recommended by the experts. Mr Stephens says: “It is important to sit tight and wait for the dust to settle but this may take a little while in thin August markets with many major players on the beach. For the longer term investor, this is undoubtedly an opportunity and we would recommend investment but, as with any seismic disturbance, there will be aftershocks ahead. We would therefore advise a staggered approach over time.” Avoiding knee-jerk actions is also the advice of Mr Hollands. He says: “If you are a truly long-term investor, take care not to act rashly during period of heightened volatility or to get blown off course from your long-term plan. Rather than pile in aggressively or liquidate holdings, take any actions in stages. With valuations spiralling lower, some might be tempted to invest. However, we remain very wary of emerging market equities and believe the current turmoil could play out for some time yet … China’s vast credit binge could yet unwind into a full blown crisis with the cracks in the Chinese system only starting to emerge properly.”

Is there any good news?

Yesterday, in a move designed to calm the panic in its markets, the People’s Bank of China cut the one-year lending rate and allowed its banks to lend more money. Global markets rallied as a result and recovered much of their losses, with the FTSE 100 posting its biggest rally in four years, but while US markets rallied in the morning, they closed sharply lower. This morning, Europe followed suit. The turmoil makes it considerably less likely that interest rates will be hiked in the near future, which is good news for borrowers but will mean that savers will have to put up with desultory returns for longer.

In addition, uncertainty in China could bring an inflow of investment to other markets. Rob Donaldson, head of M&A and private equity at Baker Tilly, says: “A possible side-effect is that investors will now be more likely than ever to look to make their money work for them elsewhere – including in the UK. Chinese companies and investment firms who have entered the private equity market are increasingly looking to the UK, and this this trend could accelerate.”

However bleak things may seem, there are reasons to be positive, says Laith Khalaf, senior analyst at Hargreaves Lansdown: “A lower oil price will boost household budgets in the UK, Europe and the US, which should feed through into spending. The $70 dollar fall in the oil price over the last year puts $6 billion more into the pockets of oil consumers each day; a level of economic stimulus even central bankers would be proud to notch up.”

Heather Miner, head of strategic advisory solutions at Goldman Sachs Asset Management, believes that global economic fundamentals are strong despite the sell-off pushing major equity indexes into “correction territory”. She says: “Although there are signs of a slowdown in the Chinese economy and the broader emerging markets, data in Europe point to a modest acceleration in growth. When compared to headline events, we view these trends as the more significant factors, which should drive long-term market performance … however, investors should anticipate higher volatility, especially in equity markets - and be prepared to exercise patience.”