Trader’s Narrative

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!
Continue reading ‘China’s Bubble 2.0 Threatens Global Recovery’

While the Chinese stock market bubble was brewing, a lot of people ignored it and frothed at the mouth about the over-valuation in the US market.

In keeping with that odd behaviour, while the US market has now fallen less than half the distance of the Chinese market (from their respective October 2007 tops), most people are more concerned about the US markets and again are ignoring the very real and brutal bear market in China.

Part of the explanation is that the US markets are obviously much larger and have more significance on the world stage but still, a bear market is a bear market. And over in China they are grappling with a big one.

Bubble, Bubble, Toil & Trouble
The Chinese stock market has gone through bubbles before. This time it only multiplied by a factor of 6 in less than 2 years!

But tha’s nothing compared to 1991 when it multiplied by ten in about a year. Remarkably this recent mania was so strong that it shrugged off a trading stamp tax increase last summer and continued to rally for a few months. Usually such state manipulation would have meant a quick death to the mania.

Click To Enlarge Graph:
To the left is a graph showing the S&P 500 and the Shanghai Index since March 2003, the bottom of the last bear market.

Since the bull market in Chinese shares lasted longer than most predicted, it is safe to say that the bear may last longer also. The next level of support is around the 3000 level. After that, the resistance levels from 2000-2001 will come into play at the 2000 price levels.

Probably the best timer of Chinese stocks has been the editor of the newsletter, Cabot China & Emerging Markets Report. Their virtuoso performance in BRIC emerging markets brought them the trophy of the best newsletter in 2007. For the record, they turned negative in November 2007 right after the top and are continuing to stay away.

The editor, Paul Goodwin, uses an extremely simple way to enter and exit the market: 50 day and 25 day moving averages of Halter USX China Index (HXC). That’s it. Trading doesn’t have to be complicated.

Chinese ADRs
Although there are quiet a few individual Chinese ADRs trading on US exchanges, the only way that I know to actually trade Chinese equities (the A shares) is through the Morgan Stanley A Shares Fund (CAF). It has fallen from almost $61 in October 2007 to its current price in the low $30’s.

As a trading vehicle it is an imperfect one because it doesn’t track the Shanghai index very well. But unless I’m mistaken, it is the only way to get your hands on those A shares from outside China.