Wednesday, 28 February 2007

Stock Market Fall: Banks, Rumours and Taxi-drivers

Stock markets around the world continued to fall in the wake of the Chinese stockmarket wave of yesterday.

In the end, I suspect that whilst it might seem like a large Chinese ripple effect, that the US market in particular was just looking for an excuse to sell-off. That aside the Chinese market was presenting signs of bubble like behaviour with PE ratios getting ahead of themselves.

There were a number of points that I wanted to blog on today but after reading an excellent post byChina Matters titled "Take the Money and Run" that links to a 1st Feb 2007 article in Time magazine HERE I have changed tack and will just provide a short overview.

The beginning of the TIME article is the standard "crash" ttext that they trot out every time stock markets run away with themselves and then suffer large one day declines e.g. Tulips, south-sea bubbles, dot.coms, 1929s etc. but then discusses the issue from a Chinese small investor perspective. The article touches on some of the issues outlined in my previous two posts:

China Stock Market Crisis
and
A look at the fundamentals

The following quote is from the China Matters post and is a good quote. Although we have heard this all before in the West it may be new to many small Chinese investors. It comes back to the greed and fear equation I discussed yesterday.

Last year 2.4 million investors began trading stocks through the Shanghai exchange, a 250% increase in new accounts. That's an average of about 7,000 a day, a flood of fresh blood from san hu (as the Chinese call small investors) that is making seasoned traders nervous. "When you see shop assistants and taxi drivers racing out to borrow money to buy stocks, you've got trouble," says commodities guru Jim Rogers. "That's the market sucking in a whole lot of neophytes priming to get slaughtered."

The rest of the China Matters article is spot on in my opinion and is a well written piece. I quote large chunks of it here as it saves time going over many of the same points.

The main points are:

1. The US stock market falls are not China specific.
2. The idea that bank loans have been taken out to fund share purchases.

Both are important factors. The second mirrors the behaviour of East Asian banks just before the 1997 currency crisis where real estate speculation was to blame.

From China Matters:
Some observers apparently thought that the rumor of an impending capital gains tax was enough to end the party.

I tend to attribute the crash to reports of an impending government crackdown against illegal bank loans i.e. bank loans taken out for ostensibly for business and capital construction purchases but diverted to stock market speculation.

This is probably as close to a smoking gun as we’ll get, from China Daily on January 30:

China's banking regulators have banned commercial banks from giving loans for stock investment and to investigate and call in all loans suspected of being used for such investment.

The China Banking Regulatory Commission (CBRC) would dispatch officials to examine loans at all commercial banks after the Spring Festival, which will fall on February 18, said an official with the China Banking Regulatory Commission, who declined to identified.


A crackdown right after Chinese New Year.

Just when the market crashed.

How about that.

The first thing the banks do when they hear about a possible audit is to try to call in suspicious loans and clean up their books; and that would be the signal for the speculators to realize their gains and get out of the market.

As to why the loss of 8% in market capitalization on a highly speculative bourse with minimal foreign exposure would give the New York Stock market the heebie-jeebies: it would be a dismaying indication of the tangential bad news that U.S. traders were looking for to confirm their own pessimism.

If I were in the U.S. markets, I would worry less about a much-needed $100 billion correction in Shanghai, than I would about the absolutely catastrophic news that the OMB was correcting its growth estimate for fourth quarter 2006 U.S. GDP from a heartening 3.5% to a dismal 2%.

That’s an overestimate of 75%, representing a contraction in anticipated GDP of perhaps $50 billion for the quarter, with a commensurate reduction in profits translating into a shrink in market capitalization of perhaps $200 billion based on real world—as opposed to speculative—valuation.

And it’s a sign that the U.S. is continuing to plod into a recession instead of pulling out of one.

For China, on the other hand, the crash is good news for everyone except, inevitably, its mismanaged banks, which have probably accumulated a fresh inventory of funny paper for their bad debt portfolios.

Fewer loans are written, macro control of the runaway economy is strengthened, inflationary pressures are reduced, the hemorrhaging of money from productive to speculative endeavors is staunched, and taxi drivers and shop assistants learn a salutary lesson about the risks of capitalism.
The big money players, I suspect, didn’t get skinned.

They took the money and ran—away from the stock market and back to the bond market and banking system.

That’s something I suspect doesn’t bother the government one bit.


I could not have put the bold print bit any better myself. Good piece.

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