Where is China in the Sentiment Cycle?

China has been headline news once again following the mini-devaluation of its currency as the government attempts to prevent its economy slowing further; volatility in financial markets has risen, but what happens now and how should investors react?


Malcolm Melville

Malcolm Melville

Wealth Preservation Manager

Source: Schroders. For illustrative purposes only.

China’s Sentiment Cycle

According to latest figures growth in China is slowing. Given China is the world’s second largest economy and global growth remains sluggish at best, investor uncertainty has risen and as a result markets around the globe have corrected.

As an investor, deciding on your next move can be difficult, will markets rebound or continue to fall? Is the worst over or is there more pain to come?

In times like these, crunching the numbers and looking at the economic data can be useful, but if the numbers only reflect reality it can be hard for investors to make a decision.

Another approach is look at China through the prism of the Sentiment Cycle.  

The infographic above shows how China has moved round the cycle. Based on this analysis China has further to go before investors can buy with confidence.

How close is China to capitulation?

Investors should buy assets as they emerge from “Out of Fashion” and sell as they enter “Blind Faith”.

China is currently in the “Acceptance” phase of the cycle. “Capitulation” hasn’t been seen and the economy may spend years in “Out of Fashion” before a new bull market starts.

For related content:

October 2015 economic infographic

How would an interest rate rise impact my investments

China stimulus to boost sentiment but not growth yet

What is a currency war and should investors arm themselves?

We are avoiding Chinese assets and other assets which are dependent on the Chinese economy.

China in “Out of Fashion” was characterised by the Tiananmen Square protest of 1989, the 1993 devaluation and the Asian crisis in 1997.

The evolution of China’s economy

Since then the economy has changed beyond recognition, as the reforms of the 1990s started to pay dividends, enabling the move into “Early Adoption”.

The strong growth between 2002 and 2007 allowed China to move through the positive sections of the Cycle.

Faith in the economy’s ability to withstand shocks was cemented with the rapid recovery following the Global Financial Crisis (GFC).

The successful navigation of a crisis is often the last event before entering “Blind Faith”. Investors started to accept Chinese growth forecasts as fact, without question.

They have forgotten it was the reforms of the 1990s that set the stage for the years of prosperity and not a new found ability to generate growth by saying “GDP will be 7%”.

Investors have yet to give up on China completely and importantly it needs to spend time in 'Out of Fashion' while the excesses are unwound.

This “Blind Faith” conditions investors to ignore the warning signs, such as the build up in credit (which generated the post-GFC recovery), until asset prices fall too much to be ignored.

Commodities were the first asset to respond to Chinese economy weakness and moved investors into the “Acknowledgement” area.

However, it was not until the stockmarket fall in mid 2015 and the mini currency devaluation of August this year that investors recognised fundamentals have changed.

Where next for China?

The stages of the Cycle are proportional to each other in time, although there is no exact relationship.

China took 10 years to move from “Out of Fashion” to “New Paradigm” and has since taken seven years to reach “Acceptance”.

Investors have yet to give up on China completely and importantly it needs to spend time in “Out of Fashion” while the excesses are unwound.

We are avoiding Chinese assets and other assets which are dependent on the Chinese economy.

This can be achieved quickly with bankruptcies and reform, or much more slowly by propping up failing institutions with endless supplies of new credit.

The latter is less harmful in the short-term and is probably more politically acceptable but will be painfully slow. Whichever route is chosen, from a sentiment perspective, China is not out of the woods yet. 

Important information

This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.

The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.  Exchange rate changes may cause the value of any overseas investments to rise or fall.

Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.

Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.