China Shanghai & Shenzen Blues

I have mentioned before that the most dangerous external event that could rattle global equities is the Chinese markets. Extended Labor Day Golden Week holiday is coming in the first week of May, generally I would not expect the authorities to try anything silly before the mass exodus of Chinese back to their hometowns all across China. Economic growth was a stronger- than-expected 11.1 percent in the first quarter, compared with a year earlier, while inflation hit a two-year high last month at 3.3 percent. Apparently the authorities were not happy with the recent huge growth figures and higher than expected inflation. Some ten banks were roped in by the Banking Regulatory Commission and were reprimanded that they needed to rein in their loans growth rates in order to minimise future NPLs. The 10 are Construction Bank, Bank of China, Bank of Communications, Merchants Bank, CITIC Bank, Shanghai Pudong Development Bank, Minsheng Bank, Industrial Bank, Huaxia Bank and Zheshang Bank.

I have noticed some interesting postings by Moola and MooMooCow (my that sounded like I am writing a children's book) on Shanghai. They highlighted Marty Chenard's article (in Safehaven.com) which had the chart above, thanks guys. I agree with Moola who mentioned that some of the credit card balances and mortgages may be leveraged upon to invest in the stock markets as well - very frothy. If one were to look at the performance last year, which was exceptional, and the follow through activity this year - you can get a lot of tells. There had been a deluge of new account openings this year. The two silly drops of 9% and the recent 4.5% were on flimsy rumours and fears, which is troubling indeed - lack of sophisticated institutional investors, loads of herd mentality and momentum investors and panic-driven as well when the time is right/wrong.

"This is definitely a bubble in the making - for most stocks, positive earnings growth has been priced in until 2009," said Steven Sun, HSBC equities analyst. "At the height of the last bubble [2000-01], we saw investors opening 2m accounts a month, which is half the current rate." Again taken from Moola's blog, the fact that there are 4m new stock accounts a month being opened in China in 2007 is a very worrying trend.

If we were too look at the chart above, the triangle surges looks worrying and excessive, well 4m new accounts would do that to you. 4m new accounts a month would also seem to be IGNORING the danger signs, and IGNORING the fact that Chinese equity markets is very much a policy-driven market (i.e. things can change very fast with new fiscal measures).

Fact is 2006 was a very good year already for Chinese stocks, but the animal has been injected with glucose in 2007, just compare the volatility and gradient of the surges in 2007 compared to 2006. Does this mean I am bearish on Chinese markets? Yes and no, please read the following carefully (point (f) being my strongest conviction):
a) the markets there will need to correct
b) the authorities there is getting antsy
c) nothing will be done till after the extended May holidays, at least let them have a nice holiday before clobbering them over the heads
d) the authorities have reminded and warned players, banks and brokers numerous times already this year on the likelihood of stringent fiscal measures if the excesses are not controlled
e) probably no Asian market is that positively viewed than the Chinese markets in 2007, so excessive valuations are normal to an extent, a lot of companies are trading at 40x - 60x earnings already
f) even if you look at the above chart, which is frightening, you can drawn a line on all the low points and it points to a very BULLISH undertone for the rest of the year: so even in a 10%-15% correction (which is VERY LIKELY, VERY SOON), there will be enormous support buying activity at critical levels

If I can sum it up, a big whack down is likely very soon and that can destabilise all markets, but the overly strong undertone will ensure for a swift rebound. Be prepared for a very volatile May and June 2007.

The People's Bank of China has ordered lenders to increase the reserve requirement six times since July to remove more than 1 trillion yuan from the market. New credit growth jumped 41 percent last year, while in the first quarter new loans of about 1.4 trillion yuan (HK$1.42 trillion) were made, more than the total for half of last year. I have argued before that raising these capital reserve requirement does not do anything for the markets. Neither does the benign currency appreciation. Hence the authorities will implement some stringent fiscal measures very soon - with or without that, the self-propelling Chinese speculative activity will find a way to drown themselves very soon.