The Emperor Is Very Naked

Naked is naked, how to be very naked?! Much like the fairy tale, it seems only the townfolk themselves pretend that the Emperor has clothes on. All foreigners visiting the town can see that the Emperor is very naked. Of course excesses won't deflate itself immediately based on fundamental arguments alone. Excesses tend to overshoot before collapsing. Shanghai at 4,000 does not look to be the peak yet. Maybe 5,000 ... lol ... cry also no tears then. That's the difficulty trying to predict a correction.

Already the foreign research houses are churning out reports on the dangers. Goldman Sachs have urged the central government to take prompt action to curb the bubble forming in the equity market in order to prevent possible impairment in individual balance sheets and setting back years of progress on capital market reform. The risk of market euphoria is building up.

The domestic A-share market has risen by 50 percent in value this year so far, on top of the 130 percent rise last year, pushing domestic share prices up to 50 times their 2006 earnings. To get a grip on how robust the gains are - let's assume that KLCI at Jan 2006 was 700 points, and by end of 2006 the KLCI index reached 1,610 ... dream on further as of today if KLCI mirrored the Chinese markets, the KLCI index would be trading at 2,415! OK, even if you ignore the 130% gain in 2006, and take the KLCI at 1,117 beginning this year, a similar 50% gain ytd would see the KLCI trading at 1,675! Wouldn't that be wonderful?

The combined total turnover of both bourses reached 310 billion yuan (HK$315.08 bn / US$40.38bn / RM137.3bn) yesterday. Despite the index rise slowing, new A-share account openings reached a record 4.78 million last month alone, surpassing the total number of new accounts opened for the whole of last year. The survey also revealed market capital locked in the A-share market amounted to 980 billion yuan as of end of last month, with both incoming and outflowing capital reaching record levels. Capital inflow per day has soared to 11.2 billion yuan (RM4.9bn), from 3.2 billion yuan (RM1.42bn) two months ago.

Standard Chartered chief economist Stephen Green said market capital is now worth more than 70 percent of China's gross domestic product. "This means there will be a major economic impact if there was a correction of 30 percent today, with the pain concentrated among small investors," Green said. He said the action taken will be more significant when the Shanghai Index moves toward 5,000, which he predicts can be reached in one month.

Naturally the bears have stated their case, but to be fair the bulls would have to have their say as well. Their main justification is absolute real earnings. If one looks at the valuation using the 2007 1Q results, one would see an entirely different picture. Out of the 1364 companies reported so far, the average earnings per share went up 78.1%. Big companies are carrying the flag waving with record profits being announced daily. Bao Steel last week reported a 154% earnings increase. China Life Insurance, CITIC Bank all reported record earnings. That's also why its easy to convince local Chinese investors to continue to pour funds into an overheated wok. This is also why it may not be so easy to kill the bull run, not when record new account openings are being registered each passing month. Willing sellers find even more new willing buyers, so much so the people who sold had to buy back again. Not a nice recipe, so enjoy while you can while the rest of the world watch Scary Movie 4, waiting for the shock (its coming, its a scary movie after all, it has to come.)