A strange thing happened on the way to the Chinese market…….
Late last year, China made reforms to open its Shanghai stock market to foreign investors, encouraging the internationalization of its capital markets. As their markets become more integrated with the rest of the world, the goal is that the renminbi (the official currency of the Peoples Republic of China) will become widely accepted as an alternative investment to U.S. dollar denominated assets. While allowing individual and institutional investors access to these markets does broaden their exposure, it creates a recipe for disaster. In the last eight months alone, the Shanghai stock market (A shares) had almost doubled in price and then saw a tremendous sell off over the last few weeks. Recently, many participants have speculated in this market using leverage, reminiscent of the late 1990’s tech bubble in the U.S.
Now, global investors are questioning the stability of the Chinese markets and the need for the Chinese government to implement regulations on investment activity.
Does this mean that investors should avoid the Chinese stock market and seek refuge in U.S. assets? Not necessarily. It is important to note that China is the world’s second largest economy and its stock market capitalization is second only to the U.S. market. Since the U.S. is a significant trading partner with China, a shift in the capital markets and a slowdown in the Chinese economy could impact U.S. GDP. According to The Economist November 29th 2014 edition, a 2 point drop in Chinese domestic demand for two years would only reduce U.S. GDP by a quarter of a point.
At this point, the events in China have had only a minor impact on the U.S. economy and stock market. Based on our extensive research, we are quite selective in the type of assets to include in our stock portfolios. Currently, we maintain less than 1% direct investment exposure to China. As the Chinese market develops and matures, we will modify our strategy to pursue opportunities for our long-term investors with a focus of optimizing risk versus return.
John C. Remm, CFP®, CFA
Senior Financial Advisor, ARQ Wealth Advisors, LLC