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China’s stock market opened the year with a bang, and not the good kind. The Shanghai stock index plunged 7 percent, triggering a global selloff in equity markets as investors again fretted about the health of the world’s second largest economy. The catalyst, once again, was investors’ focus on China’s waning manufacturing sector, which showed another month of softer activity. That focus continues to suffer from myopia.
For one thing, the market reaction ignores signs of relatively robust health in services. Services have been the main driver of China’s growth for three consecutive years, raising their share of GDP to over half compared to about a third of GDP for manufacturing. In the latest selloff, market commentators reacted to the fifth consecutive monthly reading of less than 50 for the manufacturing in the Purchasing Managers’ Index (PMI) published by the National Bureau of Statistics and a similarly below 50 reading from Caixin, signaling slowing growth, but ignored the 54.4 point reading for services in the NSB index, the highest since October 2014. The manufacturing PMI didn’t tell us anything that was not already readily apparent—that actual manufacturing growth has slowed in 18 out of the last 19 quarters. In short, markets overreacted to what in effect was very old news.
Foreign markets also overreacted to the Chinese mid-summer stock correction, which by late August saw a 43 percent price decline in the Shanghai composite index from its June 12 peak. But this decline had little measurable effect on China’s real economy. Third quarter GDP growth was down by a tenth of a percentage point compared to the first half. The services sector actually strengthened on the back of stronger private consumption expenditures, however. The latter are determined by the growth of disposable income, which has been quite strong, and the moderation in China’s still sky high household saving rate.
Only six percent of Chinese households have direct exposure to Chinese equities. As a result, predictably, the wealth effect on private consumption expenditure has not been evident. The same is likely to be the case if the latest market correction continues into the new year.
