26 February 2020
Foreign short sellers are only partly responsible for the downtrend in the mainland stock markets. Photo: Bloomberg
Foreign short sellers are only partly responsible for the downtrend in the mainland stock markets. Photo: Bloomberg

Is a systemic crisis breaking out?

The global economy is in a worrying state.

It seems like systemic risk is emerging.

Since June 12 last year, mainland China’s stock markets have gone lower and lower.

It looks like what happened on Wall Street in 1929 — a bottom followed by another bottom, and so on.

I guess there will be three “bottoms”, or waves, along the way.

The first wave was the turmoil since June last year, when the Shanghai Composite Index (SCI) fell to 2,850 points from 5,167. This was attributed to deleveraging efforts.

The second “bottom” is what we have seen since the beginning of this year, which is mainly due to the significant devaluation of the renminbi.

The devaluation made mainland investors lose confidence in renminbi-denominated assets and caused increasing capital outflows.

As I mentioned in a previous article, the Chinese government should restrict the outflows using administrative methods. It did.

However, the downtrend in the mainland stock markets continued last month. Why?

I believe foreign short sellers are only partly responsible for it.

The main reason is the lack of confidence of mainland Chinese in the future. They have chosen to move their mainland assets to overseas markets.

China’s foreign reserves shrank to about 3.23 trillion yuan (US$500 billion) in January. There’s not much left to defend its currency.

Luckily the US dollar has weakened recently, relieving pressure on the renminbi to depreciate.

I said previously that it was possible for the Dow Jones Industrial Index to fall to 15,000 points, the SCI to drop below 2,600, and the Hang Seng Index (HSI) to decline to between 18,000 and 19,000 points.

The HSI has already hit the target, and the other forecasts have come close to being realized.

It feels as though, after the Lunar New Year holiday, we are entering the third “bottom”.

A fundamental question is: how is the Chinese economy really doing now?

There is no doubt it’s on a downward track; however, nobody can say what is really happening, or whether corporate profitability is improving or deteriorating.

The first wave from June last year mainly had an impact on stock markets; the renminbi exchange rate was safe.

However, since September, in “the second wave” triggered by the devaluation of the renminbi, which led to increasing capital outflows, the downward pressure on the Chinese economy has become even heavier.

A third wave seems to be on its way.

From now to May or June, the real economy and real estate market will become major sources of risk.

If a company’s share price cannot truly reflect its profitability, the SCI may fall to 2,200-2,300 points before the end of the first half, and the HSI could decline to between 16,000 and 17,000.

This article appeared in the Hong Kong Economic Journal on Feb. 16.

Translation by Myssie You

[Chinese version 中文版]

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adjunct professor in the Department of Finance at HKUST Business School