Trader’s Narrative

How’s this as a strange contrarian indicator for the Chinese stock market? This is a billboard advertisement for Yinji Shopping Mall in Zhengzhou featuring a hanging mannequin next to a graph of the stock market:

The agency behind the billboard explain that they are making fun of the Chinese stock market. In Chinese, the billboard reads:

It’s better to invest money here than put it into the stock market.

What I’d like to ask the agency is why do they have the graph going up if they are making fun of the market’s fall?

The Shanghai Composite has fallen 72% from its high on October 16th, 2007. Compare that with 45% for the S&P 500 Index (from its high on October 2007 to the low in October).

This mention of Chinese stocks in the most recent edition of Barron’s caught my attention:

We have 10% of our equity holdings in companies outside the U.S. We have a huge database covering 59 countries and every stock with a market cap of more than $200 million. One of the countries that looks really interesting is China. There are still 214 Chinese companies that have more than $1 billion in market value. The mean P/E on those stocks, as of last week, was 13, down from a peak in 2007 of about 56 times.
In China, you are going to see slower gross-domestic-product growth of maybe 5% or 6%, down from 9%, but there are some extremely attractive values there. And although people say you are trying to catch a falling knife, the Shanghai index is down 75% from the peak in October of last year. So China has become our largest holding in terms of emerging markets.
Steve Leuthold

Leuthold is one of the “greybeards” - market players who have seen and know a lot. So you’ve got to respect his views, even if you don’t defer to them.

Way back in May 2007, much too “early”, I began to suspect the Chinese equity markets were in a speculative bubble. When the Chinese government increased the stamp duty, for all intents and purposes, it was the death knell for the Chinese stock market. It took a few months and prices went parabolic in those final months - as they always do just prior to an implosion.

Previous bear markets:
Measured by the Shanghai Composite, here is a list of previous declines from the year the market topped to how much it fell:

1992 — 72%
1993 — 77%
1994 — 49%
2001 — 55%
2008 — 72% (so far)

Here are a few ways to get Chinese exposure:

• Morgan Stanley’s China A-Share Fund (CAF)
• Taiwan Greater China Fund (TFC)
• The Greater China Fund Inc. (GCH)
• China Fund Inc. (CHN)
• JF China Region Fund Inc. (JFC)
• SPDR S&P China ETF (GXC)
• iShares FTSE/Xinhua China 25 Index (FXI) — Edit: thanks Greg

All except the last are closed-end funds, so they may not trade at their NAV. Also, CAF is the only way I know that outsiders can get in on the A-Share’s market.

With commodities in a bear market, having corrected sharply from just a few months ago, the white hot emerging markets which relied on them for their valuations, have stumbled badly.

Here is the Russian stock market:

Notice that a long term support line going back to 1999 has been decisively broken. The index is now trading at almost half of what it fetched in May 2008. This reminds me of the Chinese stock market - which has only gotten worse since the last time I featured it in gory detail.

Here is the long term chart of the Brasilian stock market, another heavily commodity dependent equity market:

Although BOVESPA has fared slightly better than the Russian stock market, it too has clearly broken its long term support line going back to 2002.

So what does this mean?
First, a snap back bear market rally is on cue and wouldn’t surprise most here. The nature of prices and markets does not allow for a relentless fall, nor a non-stop rise.

Second, this is yet another reminder of the cyclical nature of emerging markets. They are notorious for running from hot to cold and back again. Which can be great if you keep a disciplined approach and respect your stop losses.

Third, the consequences for the more developed markets is muted since they would only gain from an easing in inflation and reduced raw material costs. While the US markets have not been anything to write home about this year, they have held up much better than these markets. And with the cycle turning from real goods to “paper goods”, that outperformance can only continue.