A Duel In China: The Government Vs. The Markets

The Chinese Communist Party has taken aggressive measures to combat its decline in the nation's stock market, which had shed about a third of its value in less than a month. First, the country's government attempted to stem capital flight by freezing the holdings of any shareholder with over a 5 percent stake in a publically-listed company (http://www.theguardian.com/world/2015/jul/09/china-bans-major-shareholders-from-selling-their-stakes-for-next-six-months). On Thursday, regulators gave markets a boost by mandating that firms, their major shareholders, or their employees buy back stock (http://qz.com/449182/china-stabilized-its-markets-by-forcing-companies-and-their-employees-to-buy-shares/). The CPC also announced a massive public services project in hopes of fostering more real economic growth. The interventionist strategy has yielded results, at least in the short term, with the Shanghai Composite Index up about 11 percent since Wednesday. Nevertheless, the action has many onlookers worried that China is simply adding more air to a bubble that had already started to deflate. The Right Call? According to Adam Sarhan, CEO of Sarhan Capital, China "is shooting [itself] in the foot" by engaging in "a textbook case of corruption and manipulation." The problem with government officials' recent approach, according to Sarhan, is that "they can't overwhelm market forces...in the long run" He believes that it's only a matter of time before the realities of the markets catch up with them. Furthermore, he told Benzinga, "you lose a lot of credibility when you start overtly rigging the system." As China tries to push further into the global economy, Sarhan thinks that the government is detracting wary foreign investors and thus hurting itself in the long run. Indeed, John Mauldin of Mauldin Economics was cited in a Streetwise Reports letter published Wednesday advising investors to "expect more volatility from China in the second half of this year and, really, for years to come." Chris Temple, Editor of the National Investor, cut China's leaders a little more slack. "President Xi is trying to clean up the world's biggest bubble and biggest corruption mess. How do you keep all this from imploding and still bring China into the 21st century?" In the short term, he said that China had about a 50 percent chance to contain its stock market crash, "because they have the tools to do it." He noted that the People's Bank of China operates as a mechanism of the central government, allowing it to tackle recent issues even more creatively than the U.S. Fed did under Ben Bernanke during the financial crisis. In a report published Friday, Deutsche Bank Chief Economist Peter Hooper agreed that the "system risks from the corruption...appear manageable." He highlighted that banks do not participate directly in the stock market, with indirect exposure through wealth management products limited to just 1 percent. He also pointed out that the country's major indices are still enjoying heavy year-to-date and year-over-year gains. Furthermore, Hooper doesn't think that the experience of the last month will deter the Communist Party from its larger campaign of economic liberalization. In the "extremely long term" as well, Temple sees a bright future for the world's largest nation. He "has little doubt" that, come a few years, "China will be at the center of a regional currency [the Yuan]" and that its role in forming the Asian Infrastructure Investment Bank and the New Development Bank BRICS "will bear some fruit." He also hopes that, over time, the country will be able to drain its debt bubble by bulking up its equity markets. The major question in Temple's mind is how China will make it from now to then. The Lesser of Two Evils With China and Greece each dealing with crises on opposite ends of the map, many investors are worried. According to Temple, "China is by far and away the bigger concern in the nearer term….If China can't keep all the balls in the air, that's a much bigger hit to the markets." He noted that "we've seen it with commodity prices already." Auerbach Grayson analyst Mohammed Al Hajj also highlighted that emerging market ETFs would likely take a sizeable hit from uncertainty in China, which could have a dramatic impact on the Middle East. Greece, by contrast, in Temple's estimation, is looking much safer. "I don't see them leaving the Euro anytime soon….and the European banking system can [paper over] whatever hit comes." Sarhan agreed that Greece didn't represent a major concern and likewise isn't worried about China either. "Neither one of those events has a [strong] correlation with the [United States] right now...we're in the midst of a strong bull market." He noted that this weeks S&P low thus far was only 4 percent off of an all-time high. But whether or not China's woes are an immediate international concern, they certainly have the country's residents on edge. How the government and private sector work in tandem in efforts to stabilize its precariously positioned equity market could spell either disaster or miracle.