Is the continuous fall in the Chinese market reason for us to get worried? There are several reasons for concern. The first of them is the recent history of the Shanghai Composite index as a leading indicator for our markets.
Consider the relationship between the Shanghai Composite and the Sensex index in recent times. The Shanghai Composite reached its pre-crisis peak in October 2007, three months before the Sensex topped out in January 2008, signalling the start of the bear market.
Thereafter, the Shanghai index troughed in October 2008, this time at the same time as the Sensex. And then the Shanghai index reached a high in August. While the Sensex did cross 18,000 briefly in April, it is currently trading below the highs it made last October.
It’s entirely possible, though, that the Chinese market marches to the beat of a different made-in-China drum. There’s hardly any similarity between China’s bank loan and investment-driven recovery and our own recovery based primarily on a domestic consumption story.
Pundits such as Andy Xie and Jim Chanos have been calling China a bubble and its stock markets have wobbled as the government tried to take some air out of overheated real estate. They have recently been joined by Marc Faber, who has warned of a possible crash in the Chinese market in the next 9-12 months. There have been no such dire prognostications for the Indian market.
But Tuesday’s HSBC China Purchasing Managers’ Manufacturing Index shows the government’s lending curbs have started to bite. The index is at its lowest in six months. Promptly, copper prices, usually seen as an indicator of base metals demand, fell to a 10-week low. That is entirely as expected, since China’s position as workshop of the world means its demand is the arbiter of metal prices.
What impact do lower commodity prices have on the Indian equity markets? The metals index on the Bombay Stock Exchange was the worst performer among the sectoral indices on Tuesday and it has significantly underperformed both the Sensex and the BSE 500.
Vetri Subramaniam, head of equity funds at Religare Asset Management Co. Ltd, points out that the average estimates for earnings growth in 2010-11 are 25-27%.
But the companies that comprise the commodities-cum-oil complex are estimated to grow earnings by around 40%. Indeed, if we leave commodities and oil firms out of the picture, earnings per share (EPS) growth will only be around 17-17.5%, says Subramaniam.
That means any slowdown in China, which in turn will feed into commodities, will have a significant impact on EPS growth in the current year and that will hurt the market.
There’s also the question about what happens to Chinese overcapacity if the economy slows and its impact on the prices of manufactured goods. And that’s apart from the fact that, for whatever reason, the China risk also rubs off on the Indian market as foreign investors still have a tendency to lump them all together.
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