Has The Chinese Stock Market Bust Arrived?

Or, has a harsh winter merely caused a temporary pause in the growth of the Shanghai Composite?

The Shanghai Composite, which monitors the major Chinese stock markets, fell 9.3% last week, closing at 4,320.77 on Friday’s trading session. This leaves the composite at nearly 30% less than last October’s historical highs. The Shanghai Composite’s weekly performance has not closed this poorly since May 16, 1997. Indeed, January marked the second biggest monthly decline in the last ten years, falling only behind the 18.2% fall last November. The losers this week clocked in at 783, with only 103 stocks experiencing any gain. In addition, the Shenzhen Composite Index, which tracks major firms and blue-chip indices, also fell to 1,274.92 at the close of last week.

This year marked the worst weekly performance on the Shanghai Composite in the last decade, propelled by the harshest winter the Mainland has experienced in 50 years. The extreme sleet, storms, and ice have halted industrial production, while goods and supplies have been difficult to deliver through the extreme weather.

Is Mother Nature to Blame?

Although many pundits are basing the financial performance of the Shanghai Composite on the weather, snow clouds are not the fundamental catalyst. Indeed, the poor weather conditions further exacerbate the underlying conditions that are weakening the Shanghai Position: lowered market sentiment and falling consumer confidence.

In fact, many analysts are closely watching the relationship between the Chinese and American economies. A recession in the United States will hurt the demand for Chinese products, even though the EU has replaced America as the PRC’s biggest trading partner.

Compounding the negative sentiment is the mixed signals given by the government – who has not shown any indication of supporting the market during any decline. In fact, last Wednesday, official media quoted President Hu Jintao cautioning that China must completely comprehend the global economy’s dynamics on the Chinese economy – if stable, positive economic growth was to be maintained.

However, in the most recent Reuters poll, Chinese fund managers believed that the Shanghai Composite would maintain above its 4,000 support level – with a potential to rise to over 4,800 within the next quarter.

Evaluating the Chinese Rollercoaster’s Market Fundamentals

All of the concerns and questions lead us to evaluate whether or not the Chinese stock market bust may have signaled its arrival on the doorstep of Chinese New Year.

Between the years of 2005 and 2007, the Shanghai Composite Index quintupled in value, and although it may appear that we are experiencing a pullback, the dynamics do not show a proportionate fall – meaning the boom is not necessarily followed through with a bust. When comparing Chinese stocks with its other Asian market counterparts, it appears that the rise and growth is indeed in line with countries that have experienced high projects for growth:

  • Taiwan’s stock market increased 2,000% between the years of 1982 and 1990.
  • In comparison to Brazil, India, and Russia, since 2003, the markets in those three countries rose quicker than the Chinese market, with Chinese equities catching up in 2005.
  • The market capitalization in China is equivalent to 80% of the country’s GDP, but when you evaluate the tradable shares, this percentage falls to only 25% of GDP. In stark comparison, in the United States, the market size is more than 150% GDP.

Therefore, when you review the Chinese market in comparison to both developing and developed countries, the major rise of Chinese equities is not flagrantly irrational – rather, it is in line with growth, GDP, and future earning potential.

Why a Bust is not on the Horizon

In addition, although a fall in the Chinese market may be coming, it certainly will not be a bust. The most important reason why Chinese equities will escape any forthcoming bust comes from one entity: the government of the People’s Republic of China . In fact, the government, through various state departments, controls a minimum of 75% of the stock markets’ equities. Adamant about portraying their country in the best PR light possible ahead of the 2008 Beijing Olympics, the Chinese government will most likely not allow a bust to occur in the market before that timeframe.

Propping up the market has been a reoccurring characteristic of the Chinese government, exemplified by its actions back in April of 2005. Indeed, with the significant amount of funds in the Chinese government’s accounts, they have the monies to sustain the Chinese market – keeping all potential busts at bays far away.

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