Photographer: Andrew Harrer/Bloomberg

Why China Chasing The Fed Could Be Bad News For the Stock Rally

Updated on
  • High rates may hit Chinese spending: Charles Schwab’s Kleintop
  • Global shares to slide as much as 20% in worst-case scenario

Investors are overlooking the threat of China triggering another pullback in global equities, according to Jeffrey Kleintop.

If officials in Asia’s largest economy continue to pace policy tightening in the U.S., the uptick in borrowing costs has the potential to choke consumer and private-sector spending more than it has in the past, Charles Schwab & Co.’s chief global investment strategist said in an interview in Hong Kong.

That could hit sentiment toward Chinese stocks, creating a similar situation to the start of 2016 when a selloff in Shanghai reverberated through world trading. In the worst-case scenario, global share markets could sink 10 to 20 percent amid a “very sharp pullback” in China, Kleintop said.

“I think it could be pretty severe,” he said. “It is an unappreciated risk in the marketplace.”

While China’s central bank says it’s focused on domestic factors when it comes to monetary policy, Federal Reserve tightening risks destabilizing the yuan as it narrows the yield advantage enjoyed by Chinese assets. The People’s Bank of China boosted borrowing costs hours after the Fed in March, a move that has kept the currency supported. Beijing will also be mindful of raising the U.S.’ ire when it comes to the yuan, Kleintop said, with a decision expected as soon as this week on whether China will be labeled a currency manipulator.

Blackstone Group chairman and CEO Stephen Schwarzman, one of U.S. President Donald Trump’s top economic advisers, told Bloomberg TV Tuesday the administration is unlikely to label China as such when it issues the report mid-April.

Read more here about how China may play the yuan going forward.

‘That Was China’

Fed Chair Janet Yellen and her colleagues have penciled in two more rate hikes for 2017, on top of one executed in March. Meanwhile, economists expect the PBOC to raise the cost of short-term funding at least twice this year as it keeps a tight rein on money markets.

While equities in China and beyond have shown signs of losing steam following last quarter’s surge, policy tightening doesn’t seem to be rattling markets, yet. The Shanghai Composite Index climbed to its highest level since January 2016 on Tuesday, though some Chinese equity investors are already turning more cautious, saying rising rates are likely to crimp corporate earnings.

“A year ago we had this big drop in the market,” with the S&P 500 Index tumbling 11 percent in early 2016, Kleintop said. “That was China. That’s a globally correlated risk we could see rear up later this year.”

Kleintop is overweight on technology, health-care and financial stocks, and underweight on sectors sensitive to borrowing costs, including telecommunications, utilities and developers. He favors large-cap shares as smaller companies trade at pricey valuations. Charles Schwab had about $2.9 trillion in client assets as of February.

Chinese policy makers would do well to not ignore the risks that could emerge from monetary tightening, Kleintop said.

“They watch it and they watch it and then they freak out because they waited too long, and the markets do the same thing,” he said. “They could see it coming early enough to change course.”

(Updates with Trump adviser’s comment in sixth paragraph.)
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