Wednesday, 16 May 2007

"Bursting Chinese Bubble" - a contagion effect?

There have been many articles written on the ineviatable crash in the Chinese stock market.

In yesterday's FT there was a letter that I repost here. I have to say that I disagee with the writer of this letter.

I have highlighted in bold the areas of disagreement.

For one, as we saw with the 9% fall in the Shanghai market earlier this year, there appeared to be a knock on effect. However, after looking at this more closely Shanghai was merely a trigger that led investors and institutions to look more closely at US market fundamentals.

As was pointed out then, the Chinese market is still tiny by any measure. It is still relatively closed and is being fueled by local retail investors (with millions of retail accounts being opened this year alone).

In the UK there are numerous China based companies listed on AIM and the main market (see my previous post on this Shanghai 2006-2007 vrs Nasdaq 2000-2001). What is clear is that these stocks have not seen anything like the rises seen in China (if any). This will also hold for Chinese stocks listed in Hong Kong and elsewhere. If one examines the PE of this other shares they are on entirely reasonable ratings (as are the rest of Asian stock markets).

(Aside - the recent news that China "Investment from China" now allows overseas share buying boosted other Asian stock markets that now expect a wave of Chinese money to flood in). This may take pressure of the A share markets in the short term and could, long term, lead to a contagion effect. However, for the moment this is not a worry.

It is the relatively restricted Chinese stocks are the exception. Whilst a crash is inevitable there is no reason to suggest that the fallout will be globally or even regionall widespread.

The letter below misses the point - Hong Kong is NOT sure to follow. Investors ARE able to distinguish between China and other emerging markets. The Chinese bubble will cause pain to the "last suckers in" but investors in blue chip firms in the New York and London can rest easy. The resticted nature of the Chinese market ensures this.

The coming crash in Chinese stocks

Sir, Six years ago, according to an article in the FT, Wu Jinlian, an economist with the State Council Development and Research Centre, described the Chinese market as worse than a casino. Not much has changed. The lack of transparency, corporate governance, free press and property rights has divorced the Chinese market from any economic reality. As Cheng Siwei, a senior member of the National People's Congress, pointed out, only 30 per cent of the more than 1,300 listed companies had investment value. In relationship-based systems such as China's, "truthiness" has been mistaken for the truth of a rule-based market.

What has changed are the effects. In the past six years the Chinese economy has become a major factor in the world economy. When a bubble bursts in China, it will not stay in China. If the government decides to support the market, it fortunately has the cash. Unfortunately, it is in US Treasury bills. If there is no intervention, the debris from a crash will unsettle a rising Chinese middle class and their political apathy.

Where Shanghai goes, Hong Kong is sure to follow. It is doubtful that investors will make a distinction between China and the rest of the emerging markets, so undoubtedly several more will fall. The problem in China is that the stock market is not the only bubble. Speculative bubbles also exist in property markets upon which much of Shanghai's economy depends. China's irrational exuberance has also been driving commodity prices around the world. These markets will be tested along with much of the financial engineering involved in private equity, hedge funds and credit derivatives. And pensioners in the US may wake up to discover that their interests are being determined in a Beijing court presided over by a retired Peoples Liberation Army major.

The collapse of the Chinese stock market is not a question of if, only when. The real question will be how many dominoes it will take with it.

William Gamble,
Emerging Market Strategies

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