Nervous about the Chinese stock market? You should be. First, it looks expensive, even after a dip. Second, the authorities in Beijing, by adopting increasingly desperate measures to prop up share prices, are sending an unmistakable message that they fear a crash is a possibility.
The latest official attempt to manipulate the stock market would be laughed out of court if it were attempted in the west. The central bank is shovelling cash towards a state-backed finance company that lends to individuals who would like to make bigger bets on the stock market than they can afford. That’s right, in today’s communist China, there are subsidies for stock market speculation.
By way of further encouragement, the state itself is piling in. A state-backed wealth fund is buying blue-chip stocks. Meanwhile, supposedly independent brokers and fund managers have decided this is the ideal moment to invest the equivalent of £12bn and pledge not to sell until the main Shanghai index has risen at least 20%. This extraordinary effort, apparently, is required to “uphold market stability”.
So what catastrophe has befallen the Chinese stock market? Well, nothing to justify all-out panic. Having risen 150% in a year, the Shanghai Composite Index has surrendered 30% of its gains. That’s how excitable developing markets often work: an enormous rise can be followed by a smaller fall. It’s not unusual. And, at about 20 times earnings, the Shanghai market is not a bargain given the slow-down in growth in the Chinese economy.
The authorities in Beijing, one assumes, know all that. But they are inventing and deploying emergency measures anyway. Why? One assumes they think a serious slide in share prices would cause financial distress among 90 million individuals with share accounts. That might damage the real economy or, conceivably, create social unrest. Alternatively, the authorities think a crash could kill Chinese companies’ long-term access to capital.
Whatever it is, Beijing has put its credibility on the line. Share prices must rise because the state, in effect, has issued an order.
The authorities may win the immediate battle with the market, though it’s by no means certain. Monday’s action was mixed. Blue-chip stocks, such as banks, rose because that is where the wall of money is being directed; small companies’ shares mostly fell.
Whatever the outcome in the next few weeks, a policy of state-directed share prices is unsustainable in the long run. If investors believe there is an official safety net to protect them from losses, the next bubble will be bigger and even harder to deflate safely.
This is a fight Beijing should have avoided. It will end badly – if not this time, then next.
Rocky Rolls
What does Warren East bring to the job of chief executive of Rolls-Royce? Two days in, more of the same, meaning another profits warning from the engine maker. Yesterday’s was the third since last October.
Only two factors in the latest dip are easy to understand. Oil and gas producers are cutting budgets to respond to a lower oil price; Rolls-Royce’s marine division, which makes almost two-thirds of its revenues from the offshore industry, was bound to be hit. Similarly, everyone knows demand for business jets is soft because oil sheikhs are feeling less wealthy and western sanctions are making life trickier for Russian oligarchs.
The third factor, though, is the biggest and most mysterious – the speed of the fall-off in demand for Rolls’ Trent 700 engine. Decline was inevitable as the engine is nearing the end of its lucrative life, to be supplanted by the Trent 7000. But Rolls-Royce needed one last hurrah from the 700 to make the progression smooth. It fully expected to get it, only to be disappointed on both volumes and prices. This looks like an old-fashioned case of over-optimism. We’re not talking marginal differences. The City cut its forecasts for Rolls’ 2016 profits by about 30%.
To compound the forecasting error, Rolls had been planning to spend £1bn buying back its own shares. East has halted the process at the halfway point, an embarrassing but correct decision. How can Rolls’ board form a view on whether the stock is cheap enough to buy if it can’t rely on internal projections for demand in the biggest division, civil aerospace?
Shareholders will hope that East’s appointment, and the arrival of finance boss David Smith last November, marks the moment when the company’s revenue and profit forecasts can be relied upon. It might, but there is always the threat that East’s promised review of operations brings yet another adjustment to reality.
On a 10-year view, Rolls remains a terrific business; the two-year outlook, however, is fuzzy.