Broker's take: Selloff in China is a correction, not full-blown crash, says Pictet

THE selloff on Chinese stock markets that has sent tremors throughout the global financial markets is a sharp correction to earlier excesses rather than the start of a long-term bear market, says Christophe Donay, chief strategist at Pictet Wealth Management.

Mr Donay says China has been a major driver of global growth since the beginning of the 1990s, and after two and a half decades of astonishing real GDP (gross domestic product) growth - between 9 per cent and 12 per cent annually - the mainland has entered a period of adjustment.

"As its economy becomes more mature, growth should stabilise at around 5 per cent within 4-5 years," he says, adding that the Chinese authorities will succeed in stabilising the economy.

The challenge is for the Chinese authorities to manage the transition without a recession or a financial shock but this is proving very difficult.

In a pessimistic scenario, if problems on China's financial markets and real economy deepen, and the authorities fail to contain the situation, a full-blown financial and economic crash in China could ensue. This is currently the biggest risk for the global economy and financial markets.

"However, we are more optimistic. The Chinese authorities retain considerable firepower to stabilise the economy. They could further loosen monetary policy, and also deploy fiscal stimulus. China's real economic growth this year should therefore still meet our forecast of around 6.5 per cent," Mr Donay says.

While emerging markets are already suffering from China's slowdown, as well as from lower commodity prices and the prospect of higher US interest rates, the strategist believes the direct impact on developed economies would be limited even if China's growth were to slump. China accounts for 10 per cent of US exports, comprising one per cent of GDP, and for the euro area, China accounts for 7 per cent of exports, equivalent to one per cent of GDP.

However, the indirect impact, through contagion to financial markets, would be significant.

"An economic crash in China would exacerbate global deflationary pressures and create a bear trend on global financial markets. Vulnerability is greater in Europe than the US. The US economic recovery is more resilient, and the US economy is also likely to benefit more from the support to consumption offered by lower oil prices," Mr Donay says.

Given the elevated risk, core sovereign bonds, notably US Treasuries, will likely remain attractive to cushion portfolios, he says.