Chinese stocks enter bear market

Markets can only be described as fickle as they gyrate back and forth depending on the latest news or earnings report and as a result direction is changing not just daily but also intra-day.  Investors in most asset classes will continue to focus on stocks especially the recently underperforming Chinese equity market (Shanghai A share index) which officially moved into bearish territory after falling by over 20% from its early August high. 

Various reasons for the drop can be cited including regulator’s curbs on the stock market, high valuations, absence of new fund launches, limits on institutional buying,  high level of new accounts adding to volatility, tighter regulations on real estate, etc, but whatever the reason the direction has been clearly downwards and the impact is being felt across markets.

The turnaround in equity markets during Wednesday’s sessions was dramatic and was led by the turnaround in Chinese stocks which dragged other Asian bourses down with it.   This outweighed any positive sentiment from Market positives so far this week including a strong reading for the German August ZEW survey which surpassed forecasts by a large margin.  This followed the extension of the TALF by the Fed, and a jump in the US Empire manufacturing survey at the beginning of the week.  

Aside from weaker equities the usual FX beneficiaries including the dollar and yen strengthened on the back of the Chinese stock rout.   S&P’s affirmation of China’s credit ratings and positive comments from China’s stats office about the economic outlook in the months ahead  failed to support sentiment.  This would have been expected to provide a positive backdrop for Asian markets but Chinese stock market jitters provided a strong headwind to local markets. 

Overall most measures of risk have seen a substantial improvement over the past few months but there is no doubt that nerves are creeping back into the market.   This time the nervousness is coming from China and worryingly it is swamping the effect of any good news on the global economy and earnings.   This may prove to be a blip on the long road to recovery in risk appetite but it is difficult to ignore such a sharp fall in Chinese stocks without looking at the potential contagion to other equity markets.  

On the FX front those currencies that are most correlated with risk aversion such as the Australian dollar, New Zealand dollar, South African rand, Indonesian rupiah, Brazilian real and Mexican peso will gyrate in relation to the moves in risk appetite.   These currencies have had the highest correlations with risk aversion over the past month and in the current environment will come under some pressure at least until risk sentiment changes again, which in this market could happen at any moment and without warning.

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