Greece was not the only country in the spotlight last week. China attracted attention after its stock market experienced extreme volatility, at one point declining 30% since its May highs. China is far more important than Greece to the global economy and so there is some apprehension among investors that problems in China could spill over into the rest of the world. Even so, we believe investors should not be concerned about the impact of the Chinese stock market on their financial situation.
First, the Chinese stock market is not hugely important to the Chinese economy. By one estimate, a mere 12% of Chinese households own stocks compared to more than 50% in the U.S. Furthermore, unlike in the U.S., the makeup of the Chinese market is not reflective of the overall economy. This means that Chinese stocks can sometimes move in the opposite direction of the underlying economy and earnings trends (chart).
Second, the volatility in Chinese stocks stems from the liberalization of its financial system. Millions of Chinese citizens now have greater ability to trade stocks, which has brought greater speculation and volatility. This is likely a temporary condition as unsophisticated investors experience losses and eventually exit the market. Over time, the quality of investors in the markets should increase and temper the speculative fervor.
Third, the recent decline in stocks has been modest compared to its gains. Chinese stocks had risen 140% since last summer, dwarfing by comparison the latest 30% decline.
Finally, most mutual funds recommended by Hefren-Tillotson have modest or no exposure to Chinese stocks. Many fund managers struggle to find Chinese companies that are friendly to shareholders and meet stringent governance standards, choosing instead to emphasize other regions.