Why does Chinese growth affect our stock markets?

The FTSE 100 is down -7.45% since the beginning of August.
The FTSE 100 is down -7.45% since the beginning of August

Global stock markets are struggling to find their equilibrium. The FTSE 100 is down -7.45% since August, the Shanghai Composite has fallen ~40% since its peak in June and the S&P 500 is down -8.43% since the beginning of August.

Many market commentators attribute the fall to the revisions in China’s GDP growth rate, down to +7.0% p.a. This spooked many traders, especially Chinese ones, many of whom are highly leveraged and had overly invested into the stock market.

Why did the stock market fall due to growth figures?
Traders began to sell shares when the growth figures were revised lower because it is believed that low GDP growth rate is a result of, and will result in, consumers spending less money; companies will earn less money and therefore so will employees.

Remember share price is tied to the earnings a company makes, higher future earnings = higher share price.

So why do growth concerns in China affect our shares?
Well, the world is interconnected. As globalisation takes a foothold we find that company earnings are becoming more related to global growth.  In order to try and maintain economic growth China devalued the Yuan:

  1. China produces goods, which they sell to western consumers;
  2. a cheaper Yuan increases the desirability of Chinese goods;
  3. this in turn this reduces demand for western made goods, which are now more expensive, reducing the earnings of our companies.

Emerging markets
They are also hit by a slowing China. As main producers of the raw materials China needs, if China’s rate of growth begins to slow these raw materials are in less demand. Supply then rises and we see a fall in price. Since June iron ore has fallen around -11% and copper is down around -17% for the year, these figures will have large affects on the balance sheets of emerging market companies and governments.

One of the main reasons our stock markets fall is because the world is becoming increasingly interconnected. A weak yuan and weak GDP growth in China reduces the earnings of our own corporations and of emerging market economies. 

Other views to consider:

  • Central bank non-intervention during the crash. The Chinese government has been trying to prop up the stock market, but in their worst week of trading they didn’t intervene until late, spooking traders. 
  • Fears that QE has over-valued shares causing a bubble. The recent fall is a natural market correction to over-priced shares and was triggered by growth fears in China.

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