Tuesday, 27 February 2007

China Stockmarket Crisis - 9% fall: Where next?

Whenever a major stock market falls 9% there will be repercussions and these were felt today across Western stock markets with the FTSE 100 off close to 2% on the day.

As always the cause of the fall is primarily economic or more specifically, fear of an economic downturn in China. The result is that many commodity stocks trading in the US fell heavily.

The BBC news website report the fall as follows:

World shares wobble on China fear

China has been one of the main emerging markets for many investors as the country's economy has grown strongly and the government has sold stakes in some of its biggest and most attractive companies.

However, the government has been looking at ways of slowing growth in order to stop the economy from overheating, and many investors are worried that it may lead to tougher regulations that will limit stock-market investment.

At the same time, there are concerns that interest rates will have to be raised in order to rein in economic and price growth, further denting domestic demand for shares.

This whole issue links back to the undervalued RMB and the question of whether China is really overheating. There is evidence that this is the case when one looks at house price inflation (and other assets) and even signs that wages are coming under pressure.

However, one needs to dig a little deeper for the reason for this fall (lurking in the background I expect to find the little understood but highly dangerous hedge funds).

Share sale knocks Chinese market

The benchmark Shanghai Composite Index fell nearly 9%, its worst daily performance since February 1997.

The fall comes amid rumours of a crackdown on illegal share offerings and trading, as well as fears about accelerating inflation.

In addition to the well understood fear on inflation we now have the whiff of corruption and illegal share offerings to throw into the mix. The latter can have a devastating effect on the confidence of the small retail investor in China.

The question then is whether there is substance to this fall or whether it is a move by short sellers to worry the market and then profit handsomely from the fear driven into the small investor. Greed is a strong emotion for small investors - fear is always stronger and hence the reasons stockmarkets rise slowly but fall far more quickly.
Chinese markets have been performing strongly on the back of the country's stellar economic growth, and the Shanghai Composite Index closed above the 3,000 mark for the first time on Monday.

Indeed, some commentators have said that the day's slump was itself the product of speculative pressures, and that economic fundamentals remained strong.

We will post more the ramifications of today's fall in the Chinese stock market. There are certain things to look for:

1. The role of hedge funds - when they get it right they make a lot of money. When there is the perfect storm (such as a 9% fall) this can trigger a chain of events across global institutions that can have large impacts on stock markets around the world. All markets are closely inter-related by massive capital flows. When the fail they fail big.

2. The illegal share dealing clamp down.

3. The share prices of commodity stocks.

4. Moves ahead of an appreciation in the RMB.

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