Mar 20 2007
February 27th saw investors suddenly get cold feet about China and the Shanghai composite index fell 8.8 per cent with the biggest single day fall in ten years. For a day the dragon sneezed and the rest of the world looked briefly like catching a cold as the effects of Grey Tuesday went global.
Barings Global Weekly Review for March 2nd reveals the source of the sudden lose of confidence was fears that the authorities were planning a crackdown on speculators in a bid to cool the market's exuberance. In the US, the news of the Chinese chill coupled with poor manufacturing data meant prices started to fall.
The report states: "The volatility triggered a rout on global stock markets. The Dow Jones Industrial Average fell over three per cent, its steepest drop since markets reopened following September 11th 2001.
"Investors' anxiety was centred on doubts about the outlook for the US housing and manufacturing sectors. The index staged a partial recovery after Federal Reserve chairman Ben Bernanke said that there had been 'no material change' in the outlook for the US economy."
Worries over US growth led to the Nikkei 225 Stock Average falling three per cent and European markets followed suit.
Invesco Perpetual Monthly Market Roundup Overview charts the progress since Grey Tuesday, revealing the initial shocks have led to some calm in the region.
It states: "A cautious recovery on the last day of the month ensured that not all stock markets finished in negative territory. Asian stocks tended to outperform, with notable gains being registered in Korea, Thailand and Taiwan."
China particularly started to pick up as the authorities revealed that a capital gains tax would not be introduced and that greater foreign holdings in the country could be allowed.
As the fall-out of Grey Tuesday began to clear, Zhou Xiaochuan, governor of the People's Bank of China, claimed that the fluctuating prices were not down to any macroeconomic problems.
He said: "I personally believe this is not a problem on the macroeconomic level and should not lead to any major change of trends.
"China used to believe that its market is a comparatively small market, a market still under construction and in its early years, or a newly-established market gradually growing in a shifting economic system."
"However, due to the development of economic globalisation, there has been a close interrelation of fluctuations on different stock markets. This tells us that we need to speed up the development of the Chinese market."
Mr Zhou went on to tell a press conference that China was facing a problem of excess liquidity in the financial system but it was a global phenomenon.
He said: "The same problem is faced by the United States, which has a huge financial deficit, and those oil-producing countries with a rich capital reserve.
"All macro-economic regulatory bodies should pay high attention to this problem and adopt prudent and adequately stringent policies regarding the excessive liquidity."
Invesco Perpetual Asian Market Update aims to put the sudden sell-offs in the Chinese market, which followed record highs, in context, describing the Shanghai composite index as being open to knocks and "mood swings".
It states: "China has long been on the mind of investors everywhere, but its mainland stock market remains a largely domestic affair, with retail investors dominating daily trading. This has made the benchmark Shanghai composite index susceptible to sudden mood swings.
"The fall towards the end of February was the largest fall in share prices in a decade, but it had followed a year-to-date rally that had seen the index hit a record high only two days prior to the fall."
The update also reveals that the rumours of the Chinese government renewing measures against illegal stock-trading and introduction of a capital gains tax for equities that sparked the sell-off had been circulating since January.
It claims the underlying reasons for Grey Tuesday was profit-taking after the preceding record highs.
Invesco Perpetual Asian Market Update goes on to warn against treating Shanghai Composite index as a barometer for the performance of the Chinese economy - as between 2001 and 2005, when GDP grew at around nine per cent a year, share prices fell by half.
"There are many ways that China can rattle global markets. A sharp economic slowdown would likely end the commodities boom, and if China were to stop using its reserves to purchase US Treasuries bond markets would suffer. However, to believe that the Shanghai stock exchange now acts as a weathervane for global stock markets does seem a little stretched.
"The fall in other stock markets seems to be the result of a healthy correction in valuations."
At Capital Economics, economist Julian Jessops explained that the fall on Grey Tuesday was an accident waiting to happen, and the real worry could be the US market.
He said: "Frankly if it hadn't been Shanghai which started this then something else would have come along. This is because the markets had become complacent about risk and the outlook for the global economy, particularly the United States. So, although the falls in China were a trigger, it was probably an accident waiting to happen.
"The reason why the Shanghai market fell was because there was talk locally of the government taking measures to cool the market. The Shanghai stock market rose 130 per cent last year and there had been fears that it had been developing too fast."
He went on to explain that there was no logical link between what happened in China and the rest of the world as the Shanghai stock exchange is relatively small.
"I think people had simply got complacent about risk and this shock happened to have been from China and triggered a reassessment of risk. The trigger could have come from Germany, France or even Iran. Maybe China gets more focus because of the size of its economy, but it is important to understand that this wasn't the fault of China."
Looking forward he added: "Global opinion is divided as to whether or not this is a correction or not. We are more pessimistic than that because we are concerned for the global economy, particularly the United States.
"In the long term we think that everyone has to be bullish on China and especially Asia. The scope for catch up with the developed world is obviously huge. That doesn't mean that we are approaching a cyclical slowdown.
"The news from China is that the growth has been supported by an unsustainable investment boom, which has increased the trade surplus. This has led the authorities into a difficult position regarding balancing growth towards consumption. I think they will succeed, but the risks are on the downside should they fail."
The falls of Grey Tuesday themselves are not expected to have long-term effects, but what it does show how the world markets are so tightly interwoven and how twitchy traders are getting. March 14th saw further sell-off around the world following concerns about the US economy, but the next day saw recovery.
In the long-term Grey Tuesday suggests the dragon's sneeze may only turn out to be a sniffle, but with the world markets on edge, the coming weeks are unlikely to see the end of the turbulence.
