Monday, February 05, 2007
the chinese stock bubble
China's equity exchanges have long had more in common with casinos than markets. Investors were reminded of that on Jan. 31 when China's stocks tumbled the most in at least 21 months after a lawmaker said shares were overvalued. The comments by Cheng Siwei, vice chairman of the National People's Congress, fueled speculation the government will act to limit investment.
Speaking in Dubai, Cheng said only 30 percent of companies listed on the Shanghai Stock Exchange ``are good to invest in by Western standards,'' and investors in the remaining 70 percent will probably lose money. His words sent the Shanghai and Shenzhen 300 Index, which tracks yuan-denominated A shares listed on China's two exchanges, down 6.5 percent, the biggest one-day drop since the measure was introduced in April 2005.
A couple of things are worth considering here. One, when you think about what Cheng said, the biggest surprise is that Chinese stocks didn't fall more. You have to wonder if his 30/70 comment is too optimistic given China's lack of corporate transparency and government efforts to slow the economy.
Two, even after the Jan. 31 plunge, this year's gain is still 17 percent. No, that's not a typographical error. If stocks had ended unchanged on that day, they would be up almost 25 percent in little more than four weeks. How is that not a bubble?
``Every investor thinks they can win, but many will end up losing,'' Cheng was quoted as saying in the Financial Times.
Cheng's comments seem reminiscent of ones by Microsoft Corp. Chief Executive Officer Steve Ballmer in September 1999. After Ballmer, who was company president at the time, quipped that ``there's such an overvaluation of tech stocks that it's absurd,'' markets plunged.
To say ``irrational exuberance'' has crept into China would make Alan Greenspan's catchphrase seem like an understatement. Just as many investors wished they had heeded Ballmer's warning, bettors may regret not reacting more to Cheng's.
The popping of China's bubble probably won't hurt global markets the way the Nasdaq Composite Index's implosion did in 2000. That episode probably has former Federal Reserve Chairman Greenspan wishing he had done more than just raise questions about bubbles in the mid-to-late 1990s. Why the Fed didn't try to temper that exuberance will long mar Greenspan's legacy.
You can bet China's central bank governor, Zhou Xiaochuan, is thinking about what he can do to return some sobriety to markets. Whatever China ends up doing, the bubble speaks volumes about the cracks in Asia's No. 2 economy -- and misperceptions about its medium-term outlook.
One can argue that after a long period of lackluster performance, China's share markets are playing catch-up. Yet the idea that a multiyear rally in Chinese shares is afoot lacks support from the underlying economy.
Untold numbers of bad loans in banks? No problem, we have growth pushing 11 percent, Chinese officials seem to be saying. Raising hundreds of millions out of poverty? We have rapid growth. Stock exchanges that look more like Ponzi schemes than markets? Again, we'll grow our way to health.
Chinese stocks may one day be a stellar investment. At the moment, they seem more like the casinos that Chinese law forbids.
and this charming anecdote:
Last month, I sat next to a U.K. hedge-fund manager on a flight from Tokyo to Bangkok. The day before, while in Shanghai, he was buying DVDs from a salesman who said with a wink: ``If you don't own Tsingtao Brewery Co. stock, you should get in now.'' The hedge-fund manager, who refused to be quoted by name, called it his ``Joe Kennedy moment.''
in short, when the united states turned on the liquidity in 2002, flooding the markets with inflationary money supply in response to fears of a deflationary debt liquidation, it made no (indeed cannot make) condition on where that liquidity was to go. the money the fed either printed outright or encouraged others to borrow sparked the subsequent "reflation", which has found its way into every market around the globe. several real estate markets worldwide have boomed; risk premia in emerging markets debt have compressed; commodities prices have skyrocketed; and small third-world stockmarkets have flourished.
the net result has been a multifarious global asset boom funded largely by leverage -- most notoriously, by the yen carry trade. and the chinese stock market has been one of the greatest global beneficiaries.
will it be unwound? the answer is yes, in time; the more important question is how. it could be disastrous as it was in 1998, if some yen-positive news emerges to force pain onto those carry traders who (all being short yen) are not hedged against the currency effects that would drive the yen much higher in an unwinding -- it is important to note that the basis points being garnered by the traders evaporate if the borrowing currency appreciates. to the extent they are hedged, some counterparty has taken their currency risk and, if somewhere concentrated, such risk could be singularly devastating in a rapid move.
such is the risk of leverage -- sudden moves can devastate levered players, as is apparently happening with red kite and as happened with amaranth in commodities.
note that sudden upward moves in borrowing currencies -- japan yen, swiss franc -- are likely to be accompanied by interest rate cuts in those currencies. investing in franc- and yen-denominated bonds seems a potentially excellent carry-trade-unwinding play. one possible eventual vehicle is prudent global income. merk hard currency is another; permanent portfolio may be another. swiss franc annuities may be another. some major banks offer foreign-currency-denominated cds.