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Last week we reviewed the white hot Chinese stock market with a cautionary note. I wanted to return to it briefly because the situation is serious and deserving of much more attention.
Putting aside price charts of the Chinese equity market for now and turning to monetary measures, we can see something rather alarming happening. China’s M2 has enjoyed a constant rate of acceleration as shown in the chart below (in semi log scale). But in late 2008 the rate of acceleration suddenly increased dramatically:
This was a consequence of the massive stimulus plan put into motion by the Chinese government. They pumped unprecedented amounts of liquidity into their economy to offset the world-wide economic slowdown. There would be nothing singularly alarming about that since all central banks around the world, as well as governments in charge of fiscal policy, have orchestrated a collective burst of activity.
What is alarming is that the Chinese economy, stock market and especially real estate market are just now displaying bubble-like characteristics. The government controlled banking sector is a mystery wrapped in an enigma. No one can begin to fathom the amount of non-performing loans on the books. Unlike the US which went through a gut wrenching cleansing - thanks to the largess of the lobby-less taxpayer, the financial sector is once again back in fighting shape (privatized profits, public losses). China has yet to address their toxic assets
As we briefly touched on before, since last year’s low the Shanghai market has now appreciated more than 100%. Once again the stock market has enthralled the average person in China with thoughts of wealth and the possibility of making more in a month than what they earn in a year at their regular job. Speculation in the market is seen as not only a legitimate way to make money but a very lucrative one with low barriers to entry.
A sure sign of a bubble is extreme turnover. Recently, the total Chinese stock market turnover (in one day) reached $63 billion. That’s more than the combined total turnover of $58 billion in London, New York and Tokyo for the same day!
I know we’ve been having an especially humdrum summer (in volume) but also consider that within the $58 billion turnover are billions of dollars worth of Chinese shares and ETFs (traded on North American exchanges).
Morgan Stanley Asian economist, Andy Xie says in a recent research report: “The stock market is in a final frenzy again. The most ignorant retail investors are being sucked in by the rising momentum.”
Turning to the real estate market, there is more bad news. The two rock solid methods of real estate valuation: personal income to price ratio and rental yield to price ratios are beyond extreme.
Although the US per capita income is approximately seven times that of China’s urban per capita income, the price per square feet is almost equal. Rental yields on properties is negligible with most below inflation levels - meaning that the primary rationale for buyers is continued future price appreciation not future rents earned.
Like other bubbles, this will end very badly. That is for certain. What isn’t certain is when exactly the music will stop.
One clue may be the date that many in China are eyeing as the expiration date of a Chinese government underwritten put option: October 1st, 2009 - the 60th anniversary of the National Day of the People’s Republic of China. The general belief is that the government will do everything in its power to not ‘lose face’ before that date so as to not mar the celebration. Of course, whether this is true or not is irrelevant. All that matters is that enough believe it to be so.
The reason I spend so much time thinking and writing about the Chinese economy and financial markets is that they are now a significant part of the global landscape. The precarious nature of this fragile recovery is even more clear when we realize just how pivotal a role China plays. Unless the rest of the world can recover fast enough to back on its feet before China’s bubble bursts, this could get ugly.
You can play this with obvious Chinese ADR shares like Baidu (BIDU) which does a very good job of tracking the Shanghai Stock Exchange composite with an added beta boost. And you can also use Chinese ETFs and closed end funds like the iShares FTSE/Xinhua China 25 (FXI).
You can read more of Andy Xie’s analysis here.
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