Friday, May 25, 2007

Froth in the Chinese Stock Market

This article provides a few interesting anecdotes suggesting that the chinese stock market is short-term overbought and getting quite frothy:
China's stocks are the most expensive among the world's major markets after a rally that's drawn record numbers of investors. The number of brokerage accounts topped 99 million this year, with more than 300,000 opened daily. Students, pensioners and maids -- many with scant investment knowledge -- are among those who are using their savings and even living expenses to play the market, according to Chinese media reports.

About 10 percent of maids in Shanghai have resigned because they make more money trading shares, the government-run Eastday Web site reported on April 24, citing a local employment agency.

A Shanghai training company has set aside half an hour twice a day for employees to play the market, the Oriental Morning Post reported on May 17, without identifying the company.
And more here, including:
When a friend whispered several stock tips to Yan Caigen last year, the investor snapped up 30,000 shares in one of them, a cement company. The reason: the stock's auspicious ticker code, 600881, which contains a double-eight.

"I believe good codes will bring good luck," says Mr. Yan, who parks himself most days in front of a trading screen at a Shanghai brokerage, Shenyin & Wanguo Securities Co. Indeed, shares in Jilin Yatai (Group) Co., the cement company he bought, promptly tripled, earning him about $50,000. Mr. Yan gives credit for the performance to the two "8s" in the stock's numeric ticker symbol, which he considers a lucky combination.

Part superstition and part self-fulfilling prophecy, numerology is a basic trading strategy in China. The philosophy reflects the widespread belief in Chinese society that numbers contain clues to good fortune.

2 Comments:

Blogger Galileo Blogs said...

The froth is evident. My hypothesis is that both the froth and its very likely correction will be largely the result of monetary actions by the Chinese and U.S. governments.*

Rapid growth rates in the money supplies in both China and to a lesser degree in the U.S. have boosted the froth. Now, we see Chinese bank regulators trying to tamp down bank lending and growth in the money supply. They have raised bank reserve requirements several times and have cracked down on bank financing of stock purchases.

If they do this aggressively enough, it will trigger a bank lending contraction, which will drain money from the stock market. Without bank capital backing up the margin purchases, the stock market will contract. Then, as stock prices contract, margin loans will be called, triggering further stock sales. All of this will spill over into the physical economy, causing a recession or slow-down in economic growth, unless the Chinese central bank then turns around and quickly re-inflates the money supply. Of course, that could just stoke inflation.

The Chinese economy, as fast-growing as it is, is still much smaller than the U.S. economy, so I am not sure what it all means for our economy here. However, the U.S. Fed has also been expanding the money supply at a moderately fast rate, and the U.S. Dollar and Chinese Yuan are linked through a semi-fixed exchange rate.

The other factor for the U.S. is the increasingly likely faster revaluation of the Yuan, which is the same thing as a faster devaluation of the dollar (versus the Yuan). Of course, this would be on top of the long ongoing fall in the value of the dollar, which has lost value generally against nearly all world currencies.

All of it is quite interesting. If the U.S. dollar devalues further, it suggests staying long foreign securities versus American securities. Of course, if both the U.S. and Chinese market are likely to pull back, then it is time to get more bearish on equities in general. I invest in U.S.-based utilities primarily, and these stocks had quite a sell-off on Thursday. I'm not sure if the greater risk of a new round of dollar devaluation had anything to do with it.

***

*A qualification on my comment in the first paragraph. Monetary policy undoubtedly has contributed to the froth, but a certain proportion of the Chinese stock market gains has a solid base in genuine, rapid improvement in China's economy. Often, though, this is the pattern of a boom/bust. A legitimate boom caused by a major economic improvement is then artificially stimulated further by overly accommodative monetary policy. Then, central bank officials get nervous about the risk of inflation and artificially curtail the money supply, thereby causing a recession or depression.

Such needlessly exacerbated booms-busts are caused by government manipulation of the money supply, which should be provided only by private banks (and most likely based on gold or some other monetary asset).

I suspect I am preaching to the converted on this issue, though!

5:17 AM  
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