This article has been written by Anthony Fensom, a contributor for Morningstar Australia. It initially appeared on Morningstar.com.au.
Stock markets worldwide have been in freefall in 2016, with China taking much of the blame amid fears of a "hard landing" in the world's second-largest economy.
However, could other culprits be to blame for the global sell-off?
The worst-ever start to a year for Chinese shares has seen bourses around the region tumbling into bear market territory, which is defined as a fall of 20% or more from their previous peak.
According to Bloomberg, as of January 21, 2016, some 40 stock markets worldwide with a combined value of $27 trillion had fallen victim to the dreaded bear, including China, Hong Kong, Japan, Singapore and Taiwan, while Australia's market was almost in its clutches.
China's latest economic data, showing its slowest expansion in 25 years, also had the bears growling again, with billionaire investor George Soros saying that "a hard landing is practically unavoidable".
While China's economy grew by a relatively brisk 6.9% in 2015, it was slightly below the government's target, and even slower growth is expected this year as Beijing attempts its economic re-engineering from investment-led to consumption-driven growth.
Yet the news from China has not been all bad, with retail sales growing at an annualised rate of 11% in December, while average per capita urban disposable income rose by 8% last year to reach $4,740.
Services made up more than half of the economy last year, slightly exceeding manufacturing, as seen in the record 1 million Chinese tourists who visited Australia last year.
Morningstar head of equities research, Peter Warnes, has pointed out that China will still be one of the fastest-growing major economies in 2016, likely contributing more to global growth than any other top 10 nation. "China is still punching well above its weight, which doesn't say much for the rest," he says.
Unfairly targeted
BetaShares chief economist David Bassanese says China has been unfairly targeted as the main cause of falling stocks this year. "Global investors largely ignored the Chinese share market for a decade, but now they're latching onto it as something important," he says.
According to Bassanese, the main driver of falling equities has been declining corporate earnings, with Australian forward earnings dropping by around 8% in the past year on the back of declining commodities prices. "In an environment when earnings are flat to falling, it's hard to see the market rallying too much ... all the rise since mid-2012 has been due to the PE ratio, which went from cheap to expensive levels, and the market has been struggling ever since," he says.
Bassanese says the average PE for the Australian market is currently around 14 times compared to its year-end ratio of 15.6 times and a long-run average of 13.5, making the market "closer to fair value from expensive levels".
Meanwhile, U.S. stocks are facing more headwinds in the face of rising interest rates, a stronger currency and declining oil prices, he argues. Bassanese suggests the U.S. market now appears closer to fair value, "although valuations are not compellingly cheap".
Nikko Asset Management senior portfolio manager Eng Teck Tan suggests China's stock-market volatility reflects its dominance by retail investors--a situation which should change with increased institutional investment, including from overseas.
"Ownership of Chinese stocks is less than 2% for global investors, and within China itself there's a minimal wealth impact as they invest less than 10% of their wealth in the stock market; most of it is in property, fixed deposits and the like," he says. "Once China opens up its market, if the MSCI Index includes Chinese stocks in June, it will end up like Taiwan with far less volatility, and the institutional investors will discipline the market to a large extent."
Tan suggests investors pay attention to China's "new economy" Shenzhen bourse rather than the "old economy" Shanghai stock exchange in order to get a better gauge of China's ongoing transformation.
After this year's gyrations, stock investors would certainly welcome a less volatile Chinese market.
The dollar amounts mentioned refer to USD.
