Trader’s Narrative

China’s stock market ignored all that talk in the summer about a bubble and continued to climb higher. Even a stamp tax increase imposed at the beginning of June this year didn’t impede its meteoric rise:

Usually the increase in transaction costs have been an effective way for the Chinese government to control rampant speculation in their stock exchange. See a history of previous stamp tax increases and their effect on the Shanghai market.

By reaching 6000 in mid October, the index has now multiplied itself 6 times (off its low in 2005). Yet that is still not as impressive as its last bull market in the early 90’s.

If you’re still holding on to the bearish thesis on China you have a new vehicle with which to short China: the UltraShort FTSE/Xinhua China 25 ProShare (FXP). This new ETF provides you with twice the inverse of the Chinese market. But keep in mind that that is merely its goal. It also comes with a hefty 0.95% MER. And remember, you’re going long to establish a short position!

As well, the UltraShort FTSE/Xinhua China 25 ProShare (FXP) isn’t really exposing you to actual Chinese shares. The only way I know that you can get real Chinese equity exposure through North American exchanges is through Morgan Stanley’s China A-Share Fund (CAF).

A “stamp duty” or “stamp tax” is an archaic form of tax which is basically a prerequisite for a document to become legally binding. For example, where levied, you would have to pay a stamp duty when you buy a house to have the deed reflect the new buyer’s claim on the property. Or when you buy stocks, to reflect the new owner.

Only a few developed places levy such taxes anymore: UK, Ireland, Australia and Hong Kong (now part of China). Usually the level of the tax is left untouched. In England for example, it has been at 0.5% since 1986.

But in China not only is it levied, stamp duties are one of the dials that the communist beaurocrats love to tweak up and down. The latest “tweak” was the announcement last week that it would be tripled to 0.3% effective this Wednesday (June 6th 2007).

I showed this graph before to demonstrate that there had been an even crazier bull market in China in the early 1990’s. In this new version it shows the dates of the previous stamp duty or stamp tax changes:

I think it is fairly probable that this increase in transaction costs will greatly reduce the mania in the Chinese equities market. It may not cause a full blown crash - although the market is down overnight as I type and is at a five week low. If you want to play the Chinese market here’s how to play it from the US.

The real question now is, where will all that money flow next? You can’t dam capital. It will find its way out, one way or the other. All you can do is try your darndest to channel it.

If they ask me (and they haven’t) I would say open the gates so that the Chinese can invest outside China.

Finally! The S&P 500 finished the day at 1530.23 - an all time high. Everybody was watching this level as it had been the line in the sand, drawn more than 7 years ago:

On March 24rd, 2000 the S&P 500 reached an intraday high of 1553 (red circle above). And for the next few months kept trying to go higher but each time it was pushed back.

In hindsight we know this level to be the last bull market top and the blow off of the internet bubble of 2000.

The interesting thing to note is that not only did the S&P 500 put in a very strong performance today, it did so in the face of some seemingly bearish cross-currents from China. Overnight, the Chinese authorities tripled their stamp tax on stock transactions in another attempt to cool the mania surging in their stock market. The Shanghai market dropped almost 7%. The last time China sneezed like that, we caught a cold (February/March 2007).

But now? We seem to have developed an immunity.

I find it still supportive that so many people, even active traders and investors, are in denial of what is right in front of their quote screens. I’ve already covered how the retail “Mom’n'Pop” investors are simply not interested. But I’m seeing much of the same from many experienced, knowledgeable market participants. They simply do not want to believe this is a bull market.

Which is more the reason why it is. And more reason why it has some ways to go.

Finally, we may very well see the market correct from this level and go into a range bound contraction as it digests the resistance. That would only be natural. In the medium to long term though, I think we are headed higher.

As I wrote yesterday, on that time horizon, it is foolish to bet against the house.