This blog entry is an analysis of the effects of China's stock market surge on the country's real economy. Nothing in this blog entry should be viewed as investment advice for any markets or assets.
The Shanghai composite index has surged 156% over the last year. A staggering number by any comparison. But, looking at long-term numbers (see tables below), like the ratio of stock returns vs. GDP growth for the last ten years, or stock market capitalization as a % of the economy, China's stock market rally is in part a "catching-up" to global peers. For decades, Chinese have favored real estate and savings deposits over equity investments. Greed, PBOC easing, capital inflow expectations, foreign inflows, and a declining property market have changed the investment landscape. It is the sudden pace of the stock market rise, the disconnect between stocks and the real economy, the use of debt to fund the surge, and the sudden participation of millions of new investors that is frightening.
Given the disconnect between the real economy and stock prices we have seen over the last year, we are in an unusual situation where a meaningful drop in share prices would probably be good for growth prospects. Retail sales and stock market gains have been negatively correlated (-.86) over the last year (see my posting China stock market returns and the real economy. Just how disconnected?). That would imply a negative wealth effect, as consumers divert money to the stock market instead of spending it in the real economy. Given the 4 million new brokerage accounts opened in the last week of May, we can assume that this trend is accelerating and consumption may continue to suffer.
The stock surge has yet to lead to any positives for the real economy. So, it stands to reason that a meaningful drop in stock prices would not only have limited negative consequences for the real economy, but may even improve growth prospects by convincing consumers to divert wealth back to consumption. Global markets will be rattled by a steep drop in China's share prices, but the country's growth prospects would probably improve.
But, we are in uncharted territory. So, at this point the potential effects of a significant China stock market drop on economic growth prospects are fairly uncertain.
Here are some numbers on China's stock market gains:
- The MSCI index decided Tuesday to delay the inclusion of yuan-denominated A-shares in the index, a move that could have brought billions of inflows into the market. Roughly 5.6% of China's shares are foreign owned. It may take a year for another decision on whether to include Chinese A shares in the index.
- The value of all of China's shares from May 2014 to early June 2015 increased by a total of $6.6 trillion USD, nearly as large as the combined GDP of Germany and France.
- $6.6 trillion USD equates to a paper wealth increase of $4,800 for every person living in mainland China over the last year.
- $4,800 is a significant sum in China. The number is roughly 64% of China's GDP per capita. If you scaled this number to US GDP per capita, the wealth increase would be equivalent to the wealth of every person in the US increasing $35,000 over one year.
- China's margin debt has grown significantly. Margin debt now accounts for 3.2% of GDP ($330 billion USD). That number is 2.9% in the US.
Margin Debt as a % of GDP for China and the US
- Bloomberg estimates that individual investors accounted for 80% of recent stock market transactions. As of the end of May, new market investors increased 83% from the previous year, according to Blomberg. 4.4 million brokerage accounts were opened in the last week of May.
- According to Bloomberg mainland firms have raised $56 billion through IPOs, about %0.5 of GDP.
- China's stock market capitalization is roughly 100.5% of GDP, compared to Japan's 145% of GDP in 1989 at the peak of its stock market rally before the bubble burst. (see chart on left)