China and You

Correlations between Chinese and global equities have increased considerably since 2007. That can easily be explained by the growing economies ties either through investment, trade or on commodities consumed by the China. An increase in exports to China is among factors supporting European exports in Q2,

The Shanghai composite index has fallen almost 20% from its August 4 peak and it looks vulnerable given the liquidity outlook and the challenges of using relatively blunt tools to guide asset markets. The fine-tuning Chinese monetary and cool overheating in some sectors in the economy could contribute to more global market volatility. A burst of Chinese bubble could lower Chinese demand and pre-figure poor performance in other markets as liquidity is withdrawn.

Since beginning of July, Chinese equities are looking very bubbly, especially its property market. Inflows to Chinese equity markets have slowed since then. Several trends, which supported the market in 1H09 – record bank lending with few restrictions, the improvement in consumer confidence, the deferral of IPOs – are no longer supportive. Bank lending slowing down and government regulators suggested a closer look on risk of economy overheating and more importantly, the price-earnings ratios are no longer as cheap, having almost doubled from their late 2008 lows. Production costs have escalated and all these factors are suggesting that Chinese equities might have farther to fall.

New accounts opened by Chinese retail investors have fallen since their late July peak. The reluctance of retail investors to incur losses could contribute to a boom and bust cycle.

Also to note that record commodity imports, which contributed to price climb in 1H09 can be easily reversible for a simple fact that Chinese commodity purchasers are price-sensitive.

I sense that the Chinese market has grown strongly and erratically over the past year and investors are starting to doubt the sustainability of the Chinese boom.