The Chinese Market And Domestic GDP: Warning Signs?

New York (HedgeCoVest.Com) – The last two days of trading last week produced a couple of news items that could be sending a warning sign to investors. In Thursday’s trade, the Shanghai Composite Index fell 6.5% for the worst daily loss since January in percentage terms and the worst daily point loss since 2008. The selloff came with a record breaking volume day with 1.2 trillion yuan worth of shares changing hands.

The selloff was spurred by brokerage firms tightening margin trading requirements for clients and the central bank took liquidity out of the money market arena. The selloff in January which created a drop of over 7.0% was also the result of tightening in the margin requirements by brokers. Official data showed that margin finance hit a record two trillion yuan on Tuesday.

Prior to the drop, the Shanghai Index was up 52.77% on the year and this had allowed emerging market and China-focused hedge funds to lead the way in 2015. Many economists and investors are concerned that the rally is extremely overblown and fueled by cheap credit and that the underlying economic activity doesn’t justify the extreme run up in stock prices.
On Friday, the second estimate for first-quarter GDP was released and it showed a contraction in the US economy of 0.7% instead of the originally reported growth rate of 0.2%. The downward adjustment was expected by most analysts.
In order to get an idea of how hedge fund managers feel about recent events, we spoke with a few of the managers on the HedgeCoVest platform.

“Today’s negative GDP figure, while expected, will likely cause traders to pause and reconsider their outlook about the timing of the first Fed rate hike. The economic spotlight has shone on the other half of the Fed’s dual mandate: jobs. Unemployment is low, but we have not seen expansion of wages. In the meantime, inflation will stay in check until there is consistent GDP growth. The uncertainty of the economic picture and the timing of Fed action, combined with global choppiness we’re seeing from the likes of China will make good stock selection even more critical in the second half of 2015.”
— Kathryn Schwartz, CEO Pawleys Capital Management

“The first quarter was buffeted by a number of one-off items, the effects of which are difficult to separate from the underlying trend. In addition, the seasonal adjustment factors the government uses may not be appropriate for the seasonal patterns that have been evident in the economy in recent years. The government has these seasonal adjustments under review. In general, there has been no change in the underlying fundamental factors that typically influence economic growth. Monetary policy on a worldwide basis continues to be highly accommodative and inflation is very low as are interest rates. We have assumed modestly positive economic growth (2.0-2.5%) for the US economy for a number of years now, an assumption we are staying with. This macro environment is very favorable for equity returns. We are continuing with a somewhat above normal net exposure to the market, a strategy we have had in place for a long time now.”
–Robert Moore, CIO and President, CMJ Partners LLC

With the remainder of this week littered with key economic reports, it will be interesting to see how the market reacts. The May employment report will be the most closely watched of the economic reports as investors try to gauge the economy and then interpret the numbers like the Fed would.

Rick Pendergraft
Research Analyst

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