China’s total stock market was eclipsed in value by Japan recently.

China used to sport the world’s second largest stock market by total value, but they have been passed by Japan.  China’s overall equities market is valued at $6.09 Trillion USD while Japan’s total equities market is valued at $6.17 Trillion USD.  This is quite a development for a few reasons.

1.  U.S.-Japan relations are under-reported and there is a stronger relationship.

While the hostilities between U.S. President Donald Trump and European Union Presidents and Prime Ministers have been well-documented along with the ongoing beginnings of a trade war with China and Canada, the relationship that the United States enjoys with Japan and South Korea could actually be considered improved.  Japanese Prime Minister Shinzo Abe’s charm offensive and buddy relationship with President Trump has actually yielded positive results.  Greater regional stability due to a firmer hand toward regional threat North Korea has been good for the Japanese economy.  Greater relations between Japanese companies and investments into the United States have also borne fruit.  

The United States’ withdrawal from Trans-Pacific Partnership gave Japan an opportunity to build economic relationships with still developing countries like India.

The hitch in this whole arrangement is that while trade negotiations between Japan and the United States have not been hostile, there are concerns that the “America First” approach of tariffs may negatively impact a positive, mutual relationship.  Japan and the United States are allies and the increased investment on the part of Japanese companies along with the frequent communications between Abe and Trump may lead to a better result.

2.  Japan’s Growth Despite Population Concerns

The above describe the very basics of the Japanese economy, there is a graying population combined with a relatively robust economy.  Issues resulting from the Lost Decade such as deflation still linger despite the efforts of the Bank of Japan to inflate the Japanese Yen.

The graying population along with socioeconomic constructs for a generation that are not procreating for a multitude of reasons nor procreate enough to replace past generations or effectively pay for the pension system of generations past is a major problem.

For an economy like Japan’s to re-emerge past China in terms of total equity value of publicly held companies is a big deal given how China has become a global powerhouse.

3.  Trade Wars are a Two-Way Street that has a lot of traffic 

Much attention has been given to how the United States will be impacted by a trade war, but less has been given to the impacts on China.  The major reason is of course much of the world’s revulsion and addiction to all things Donald Trump.

China is going to be impacted by tariffs in a negative fashion, there’s no getting around it and this drop-off in equity value is actually being credited to the tariffs imposed by the United States.

The FTSE China A50 Index

The FTSE China A50 Index has declined significantly in 2018, in fact from peak-to-current price has fallen 26.13%.  That’s indicative of a bear market in a world where the bulls have still largely maintained control.  In a globalized economy, a Chinese bear market can impact the entire world.  Consider that many companies are global and generate revenue in China, they may not necessarily have offices in China and they may be headquartered in Paris, Chicago or Sydney, but the Chinese economy impacts bottom lines.

Many are focusing on the direct impact of a trade war rather than the domino effect of one.  The domino effect is more likely in a globalized economy and everyone is harmed because there’s simply less international diversification than ever.

China has not encountered a global economic power looking to kneecap them and any punitive response deemed in any way extreme would be akin to an economic murder-suicide on a global level.  All parties have to tread carefully and given that Trump is putting Chinese President Xi Jingping’s feet to the fire in a way that he is unaccustomed, it is a test for a country that is still going through the pains of economic liberalization.

Will China set off an economic contagion?

China is already in a bear market and tariffs from the United States could make things worse.  Chinese aggression in the South China Sea may be indicative of a government that recognizes that their economic might be weakening and their military strength may be needed for the purposes of ‘saving face’ on a global scale.

The Chinese stock market matters, the 2015-16 popping of the Chinese Stock Market bubble resulted in losses on a global level.  However, the losses were not as pronounced in the United States and it was more-or-less a Chinese contagion induced market correction that provided an opportunity for investors to buy the dip.  Globally, the impacts were far more severe, but markets recovered.  Interestingly, the impacts on the rest of the world were happening at around this time three years ago (the anniversary would actually be two weeks from today) and at around the same price level for the FTSE China A50 Index.

The main difference between then and now is the sudden nature of the drop in 2015.  The Chinese Bear Market that exists currently has been falling since late January 2018.  Conditions are very different now, but it is something for investors to keep in mind as the Japanese stock market passes the bears mauling the Chinese stock market.