Home » 2007 » January » 04

Daily Archives: January 4, 2007

Search within blog:

Subscribe RSS feed

January 2007
S M T W T F S
 123456
78910111213
14151617181920
21222324252627
28293031  

A Revisit of Chinese Stock Market: Was I Wrong?

01/04/2007

In early 2005, I predicted bearish Chinese stock market in the medium term. Back then, the Shanghai Composite Index was only around 1000. Nobody quite understood how this could happen with the economy soaring every year at double-digit rate. Now, the index stands high at 2650, a 165% jump from 1000. If just count from October to December last year, the index jumped 800 from 1800, almost 45% increase. One word: unbelievable!!!

The bear market I predicted was out of two reasons. For one, there will be huge piles of state-controlled non-circulating stocks waiting be to put into the market, creating an oversupply. Two, China is working toward floating her capital account (sooner or later), domestic investors will want to invest overseas seeking better return instead of earning pity banking interest. This will create a shortfall of demand. Both forces drive down the market in the medium term. Supply and demand work like magic. Is it that simple?

It turns out the supply side of the story was right. But the privatization of state controlled non-circulating stocks completed sooner than expected. The demand side’s just totally opposite. Instead of a shortfall, we had a huge surge.

Several events contributed to the flip of the demand.

First, Chinese government announced appreciation of the yuan in the first half of 2005. And with continuing pressure from the U.S., yuan is expected to appreciate further. This contributed a huge inflow of speculative capital, part of it flowing into the stock market. This is the most important factor in this round of stock rally.

Second, with IPOs of monster big Chinese state banks, and with backings of the prestigious Investment banks such as Goldman Sachs and RBS (in return for favorable access to Chinese banking business), the market psychology turned to Chinese stock holders’ favor.

Third, Chinese government took a gradual approach on freeing its control on capital account. Although the state, in replacing individuals, begins to invest abroad, the process is too slow. The expected outflow of capital did not happen.

Is the huge outflow of domestic capital ever gonna happen? I don’t think so. Here is why? 1) Chinese investors are relatively poor informed about the foreign markets. They do not have experience investing abroad. Simply too much uncertainties out there. 2) The financial institutions in China are still backward. Institutional investors, like mutual fund and pension fund, are inexperienced either.

Now here is the tough question: With Renmingbi expected to rise further, will China suffer similar boom-and-bust in Japan since early 90s? At least, this is what economists like R. McKinnon are worrying about.

Read on, next time…

-Paul