China’s stock market should rally on inflation

Chinese inflation

Photo Credit: Reuters

Though China is currently waging a war on rapid inflation, the stock market continues to tank, even though the inflationary factors are nothing but positive. It is important to note that the Chinese inflation problems aren’t from internal inflation, but rather from its huge foreign cash reserves as a result of a large trade surplus.

Chinese inflation shows strong economy

The inflation in China’s economy is a direct result of a trade and investment surplus; the amount of money entering China from investment and manufacturing is creating a “problem” that is actually good for the country. If the United States were to receive such large trade imbalances in their favor, the result would be huge for the economy, possibly even turning it around.

Prices rise with inflation, that includes the markets

During periods of inflation, prices rise as the supply of money grows exponentially. This has yet to catch up with the Chinese stock market that has lagged after the bottom was pulled right from underneath speculators and caused a 50% drop in the biggest Chinese stock index. Now that the bottom is out, and a new floor is being created, the inflationary factors that scare the Chinese government should be encouraging investors to continue to invest in the manufacturing powerhouse.

The US stock markets grew with inflation

During the 1990’s stock market boom in the United States, the M3 money supply practically doubled from $4 Trillion to $8 Trillion, while the market rallied from a Dow price of 2700 to 11500. During times of inflation, the stock and commodities markets are the first to show higher prices, as an extremely liquid market turns over money much quicker than other illiquid markets.

Chinese stocks unfairly hit

The drop in China’s stock market isn’t fundamental, but purely speculative. Large foreign institutions pulled money out and took it to other parts of the world. The large inflation pressures that exist in China have simply yet to make back to the market, and when it does, we can only expect another large bull market run.

While the Chinese government is fretting over inflation, investors should take note and start buying Chinese stocks, which when priced for higher inflation, will likely take off like a rocket and possibly hit last autumn’s highs – not as a result of speculation, but as a result of higher prices across the board. Let the Chinese government worry about inflation, while you continue investing.  When the money comes back to the market, Chinese stocks will be ready to rebound once again.

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