Monday, April 23, 2007

They've Lost Their (Rice) Noodles

The chart below is for CSI 300, the broad capitalization-weighted index for Chinese stocks - something similar to S&P 500 for the US market. It basically speaks (screams) for itself: up 3.1 times in 12 months, with a furious 40% in just the past couple of months.

China's CSI 300

The market is white hot: stockbrokers in the Heavenly Peopledom are opening as many as 282.000 new accounts every single day. So far, a stupendous 2.76 million new brokerage accounts have been opened just in April - and the month is not yet over. For comparison, there were a total 3.08 million accounts opened in all of 2006. There are now 91 million brokerage accounts in China (is this communal capitalism, or what?). Let's pause for a second right here, because these numbers are so large they require some quickie analysis.

Back of noodle wrapper calculations, plus some qualitative observations

a) Market penetration

The population of China is 1.3 billion. Divide by 3.4 to get the number of households: 382 million. Communism or not, some people are poor and/or they don't have excess income to invest. Let's call that 30% of the population, or 115 million households, leaving us with 267 million households. Take out another 3% for those over 75 years old, and we are left with 260 million nominally "eligible" investor households. Divide 91 by 260: 35% of ALL theoretically eligible households already have a brokerage account and this percentage is now growing by 1.5% every MONTH. Who is left to buy?

b) Valuation

Total market capitalization is around $2.3 trillion, or 85% of GDP, comparable to, or higher, than most developed, free-market economies. Given the only recent explosion of market economics across China, a large share of GDP is still produced by small non-publicly listed companies, plus large state-owned concerns. This makes the 85% figure very large, by comparison. In addition, price to earnings ratios are ~50x on average, with some companies over 100x.

c) Currency

The yuan is hard pegged to the dollar - what you see in the chart is what you get, in equivalent dollar terms - i.e. it is not double-digit local inflation or currency devaluation that is goosing nominal prices artificially higher.

d) Individual Speculator Excess

For the past few years, individual speculators have been mostly absent from western equity markets, leaving the field open to professionals who have driven them slowly, but persistently, higher through the massive injection of debt capital. There has been no easily visible "excess", of the kind made famous by the dotcom mania, to point to a final western market blow-off.

However, we have exactly that happening right now in China, with indexes going vertical (see chart above). Recent global market behavior (February - March) has shown that a plunge in Chinese stocks has a quick and ugly domino effect all over the world. When the party ends in Shanghai the hangover will spread all over.

e) Debt Effects

Chinese savings finance a large part of global debt, particularly in the US. If (when) they go up in smoke, after the speculative equity bubble bursts, who will buy all the Treasury, mortgage and LBO debt that is gushing out in incredible amounts?

Conclusion: Chinese equity markets are now filled to the rafters with hard-plunging, inexperienced individual speculators, determined to make a fast yuan. The recent plunge and come-back of February-April has convinced them that they are invincible and has produced even more fever. We have seen all this before and it ALWAYS leads to pain; the higher they fly the harder they fall. This is a fact that Chinese monetary authorities are certainly aware of and should try to contain before the consequences of the aftermath become too serious for the "real" economy.

8 comments:

  1. Nice article.

    Same feeling from here in Paris. Shangai looks both overheated and, possibly as well, under-regulated.

    China still has a lot to improve upon. Not in terms of raw economics. But more on the legal and policy side.

    Will not be easy, I suspect, since the country is still of course no democracy - that can wait from a market point of view - and does not even have a proper environment for land ownership.

    As far as I know, ALL China land still belong to the state. In the end, one of the questions is : "how can you have a valid stock market when the basic legal environment is not even up to it?"

    François

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  2. I doubt China will ever truly approach what we think of as a western-style "free-market" economy. Central authority has been strong in their social structure for millennia and won't go away just because they can currently make consumer goods cheaply.

    It looks as if Chinese speculators now view their stock market as a casino with sure bets, instead of a fundamental source of primary finance capital and secondary means of liquidity, i.e. the bedrock of capitalism.

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  3. Francios,
    I was under the impression that recently China has allowed for the ownership of private property. I'm not sure exactly how ownership is structured tho.
    Which brings me to my question for Hellasious: Do you think individual Chinese have gotten recent excess to equity in either their own homes or other property and they are investing this new equity in the stock markets?

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  4. Since I'm too chicken to short the FXI or anything like that, what asset class (if any) do you think might jump up if the Chinese market pops?

    ReplyDelete
  5. The Chinese are speculating with their accumulated savings and some are also borrowing to buy stocks, particularly in Hong Kong where consumer lending is wide-spread.

    I'm not quite sure which asset class will do really well in a global correction (other than being short, that is...) Medium term notes, 2-5 years, may outperform.

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  6. Funny how these instances of wanton excess, aka GREED, are never contained. In fact, generally they are exacerbated until they implode of their own bloated weight. That is what will happen again, and just as predictably some exogenous shock will be blamed for the game going poof, though whatever the shock is, it will only be a catalyst. The nasty spill of February was a warning shot across the bow of global share markets, but the warning is not being heeded. Thanks, Hell, for another great post.

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  7. What does it do to your math if 1/3 of the punters are day-traders and have three or four accounts each as they keep switching to shop with the best rates, most generous margins, and first x-number of trades "free". Many Asian women love to punt so it is likely that within the realm of those who "can", a number of husbands and wives will trade separately. Having invested through Japan's bubble, I recall how many of Wall St.'s finest thought shorting the Nikkei in 87 was shooting fish in a barrel, but it went up their arse for another two-and-a-quarter years. You really need to wait for a significant move towards some chunkily positive real rates of interest, and this seems unlikely before the 2008 Olympiad. And to get some chunkily positive real rates of interest, you first need to be able to accurate measure inflation....

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    ReplyDelete