Monday, August 31, 2015

Its not a Chinese sell-off!

For the past week, global markets have taken a fancy to the slowing of Chinese economy. It could be envy of watching a defiant surge in Chinese markets without any hiccup what so ever. This story, it appears, has nothing to do with China and more to do with Yellen. China somehow was an opportune discovery. 

The American economy, its size, and its global linkages make it core factor in asset price calculations. The US is a primary exporter of capital to most of the important markets of the world. It is also usually the most important sizeable end-consumer for many including China. Comparatively China is less inter-connected.

A US asset price rerating will affect everyone.
There is a risk hierarchy of assets explicit or implicit in the mind of the investor.  When other central banks do such a thing their Government bonds move along the asset risk-hierarchy but other assets do not get impacted. When the Fed modifies the interest rates the whole hierarchy moves up - it affects all the asset classes. With the impending rate hike by one of the biggest economies in the world we are looking at asset price rerating across the world. 

Hike pushes investors into action
Generally a reduction in rates allows existing investor more room as prices tend to increase in case of the rate cut. However, when the Fed hikes the interest rates, the riskier asset prices depreciate. This effect tends to push marginal investors into selling thereby creating an opportunity for broader sell off. 

The current sell-off seems more likely to be such a sell-off. It is unlikely that this sell-off has anything to do with China. China unfortunately slowed down at that very time and to top it off indulged into some anti-market moves that further spooked the markets. Naturally that has prolonged and aggravated the current sell-off.

Meaning of slowing China
China is highly export driven economy. The GDP contribution from investments was growing substantially. Post the 2008 crises two things happened - China increased the investment spending - investment to GDP ratio was ~ 40%, and did it in face of tapering consumption demand. The underlying assumption being that China hoped developed market demand will take-off in coming years.

Had demand returned China GDP would still look robust. It means developed world demand has not returned - despite reasonable GDP growth in developed economies. THAT to my mind is a bigger scare than simply China slowing down.