Yesterday’s market turmoil doesn’t signal economic upset in either China specifically, or the world at large, says TD Economics in a special report.

The report notes that global equity prices took a tumble yesterday, sparked by a 9.2% fall in Chinese renminbi-denominated stocks. While other Asian markets continued to slide overnight, Chinese shares rebounded with a 3.5% gain.

“This raises two important questions. Is this a sign the Chinese economy is coming unhinged and does it signal economic weakness to follow in the global economy? The answer to both questions is no,” it insists.

TD says that the catalyst of the Chinese equity sell-off was a number of newly announced regulatory changes — and heightened expectations for further changes — which will improve the financial soundness of the domestic Chinese stock market.

“The proposed regulatory changes will limit the inflows of savings, so this set off the stock market correction yesterday and the weakness was likely intensified by profit taking after the huge run up last year,” it explains. “These changes will also likely curtail some prospective equity purchases, but largely to the extent these were being fueled by ill-advised debts and insufficient understanding of the risks inherent in the stock market. Nevertheless, it must be stressed that this week’s pullback was not a reflection of underlying weakness or overheating in the economy, but rather was a result of the Chinese government taking the necessary measures to prevent the economy from just such a fate.”

This weakness in China flowed through to global equities for two reasons, TD says, “The Chinese economy serves as a lynchpin in world-wide manufacturing production chains and it has also been driving commodity demand. Disruptions to either of these would have global implications.”

However, it notes, “Since this week’s developments should shore up the Chinese financial system and have little implications for the rest of the economy, these fears should subside. The generally larger declines experienced in emerging markets — which were coupled with rallies in bond markets — represented a flight to safety seen during any such unexpected shock.”

“The real concern would be if any signs were to surface that this week’s pullback in equities was leaking into other parts of the financial system,” TD suggests. “There are no signs that investors were overleveraged and will find it difficult to recover from their losses. In fact, the Chinese action was specifically aimed at stemming the tide before any such problem arose. Similarly, there is limited concern these losses will leak into the rest of the economy. We already expected a number of commodity prices — notably base metals — to pull back moderately but to remain high. Yesterday’s pullback in base metal prices by one to two per cent — which is a small move in view of the gains racked up to date — is consistent with our current view.”

“The Canadian and U.S. economies are in the midst of an economic slowdown, but the extent of the weakness should be limited and economic growth should be strengthening heading into 2008. This will lead to slower corporate profit growth, which might restrain the gains in equities in the near term, but the fact that corporate earnings will continue to rise and will accelerate in 2008 should support moderate returns,” it concludes. “As a result, any contagion from the recent Chinese stock correction should prove limited and fleeting.”