
China's stock markets: Coping with volatility
The recent fall in China's stock markets had some investors concerned about the prospects of the country's private equity market. GPs, naturally, downplayed the impact on private market activity, stressing that LPs should focus on the longer-term opportunities.
Indeed, after the 2008 fall, to which the current situation has been widely compared, IPOs only experienced a brief hiatus and came back much stronger in 2009. But isn't it very different and much more serious this time?
First, the fall is hardly surprising given the spectacular rise and fall of the Chinese indices. The fact that a lot of the "losers" were retail investors (many using margin accounts) and not the "more rational" institutional investors, suggests a more speculative market that is open to such fluctuations.
For example, the Shanghai Composite Index has more than doubled in the past year, soaring past 5,000 points, and in the last few weeks fallen up to 30%. It has since has recovered to the 4,000-point mark. Likewise, the smaller Shenzhen Composite Index has posted a one-month loss of around 35%, while the city's SME and Chinext boards have seen similar levels of price erosion, although some of these losses have since been recouped.
However, unlike 2008, there is plenty of government intervention this time. From the suspension of certain stocks and a crackdown on margin trading, to cutting interest rates and suspending new IPOs, the measures are a source of concern in some quarters that the government recognizes it is marshalling a slowing economy and the indices may not be able to recover on their own.
That coupled with the obvious effects of a disintegration of billions in wealth, predominantly amongst the middle class, may lead to a drop in consumer spending. It begs the question of what spillover effect this might have in other countries. The implications for private equity in this respect are unclear.
It is difficult to argue the impact will be zero, even if private equity firms' long-term objectives remain unchanged. From a short-term perspective, GPs with pending IPOs or looking to exit already listed portfolio companies will obviously not welcome this development.
M&A and trade sales are a consistent option and they may gain prominence if the market downturn is protracted. Those with dry powder will definitely welcome any dampening in entrepreneurs' expectations, leading to valuations that are closer to reality. I would also go far as to argue that a bit of market turbulence may actually be helpful to the long-term growth of the industry as it creates changes and gives rise to new opportunities.
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