Tax Cut leads to surge in Chinese Indexes

Attempting to tackle a sharp decline in the indexes over the past months, the Chinese government reduced the tax on equity trading. In response the Shanghai Composite index surged 9.3% - an increase that is almost certainly temporary. The broader issues with lofty valuations, lack of transparency, and macro-economic issues driving the fortunes of companies in Asia remain unaddressed by this regulatory action.

Investors were delighted with the government action; however it did not boost the long term confidence in the stock market for most individuals. Smart investors will take advantage of the surge to exit their positions over the next week. Slower earnings growth and higher costs do not bode well for company results in upcoming quarters.

“The government is clearly concerned about the meltdown,'' said James Liu, Shanghai-based deputy chief investment officer at APS Asset Management, which oversees $1 billion. ``It's positive for the market in the short run.''

The primary words to focus on are “short run”. Simply reducing the stamp duty on stock trading to 0.1 percent from 0.3 percent will not eliminate the headwinds facing the market, nor change the primary trend of the stock market which is down.

Despite the optimism expressed from financial pundits, the proclamations that this denotes the market bottom are likely to backfire within the next couple of weeks. Certainly the government is pleased with this cheerleading from the financial sector, because after all markets are in reality a confidence game.

Chinese stocks soar after tax reduction

Few analysts believe share prices will reach a new high this year, but many investors and analysts are hoping the worst is over. Hoping and reality normally run on diverging tracks.

Chinese markets plunge 50% in six months

Earlier HingeFire articles outlined the risk of the Chinese stock market (see The Plunge Continues – China, Shanghai Index Double Top, ETFs to short China) and the probability of the bubble would implode. A summary from early April outlined the rapid deflation of the Chinese indexes. In the past week, the Shanghai index dropped another 11%.

The deteriorating situation has caught the eye of the mainstream press. The WSJ outlines the 50% fall of the Chinese market in a mere six months as a front page article. With the P/E ratio of the composite Shanghai index still at a frothy 35, the market still has plenty of downside. To reach a nominal P/E of 20, the index would slide to 1700; a 72% crash from the Shanghai market peak. A situation that is very reminiscent of the NASDAQ in 2002.

What is that sound? It’s the market bubble bursting in China

Previous Hingefire articles in 2007 outlined the increasing risk in Chinese stock markets and how the Chinese indexes were not strongly correlated with other world markets. The Plunge Continues – China in June 2007 warned of the risk that the Chinese markets were in a bubble and it was just a matter of time till they burst. The lack of correlation to the world markets was discussed in August. A HingeFire article in November recommended ETFs to short the Chinese market.

Fast-forward the clock to April of 2008, the Chinese stock market has become the world’s leading example of a bursting bubble. The Shanghai composite index has plunged 45 percent from its high, reached in October 2007. While markets world-wide have been down since this time, other major world indexes have all dropped less than 20% in the same time period.

The frenzy that surrounded the upside of the market in China has now dissipated leaving many investors angry and demanding that the government take action. A good number of the speculators lost their entire savings. Many have learned a harsh lesson in how quickly a bubble bursts.

To See a Stock Market Bubble Bursting, Look at Shanghai

“Look,” he said, “it took two years to go from 1,000 to 6,000 but two months to go from 6,000 to 3,500.”

Increasing Risk: Real Estate in China

There is one real estate market where a meltdown would comparatively make the situation in the U.S. appear to be minor league. Only one country has both the population and rising speculative real estate values to claim this distinction – China.

A number of economists such as Yi Xianrong are sounding the alarm. There are two primary issues, the first being the false data on many mortgage applications. This is somewhat tempered by the requirement for large down payments on many real estate loans in China.

"I estimate that the large majority of mortgage holders would not meet the standards for even subprime loans," Yi said in an interview with the state-run magazine Oriental Outlook.”

The second risk is the speculative real estate spiral. A good number of owners view real estate as a money-making scheme, similar to the “flip this house” phenomena in the U.S.

“Many Chinese families are already deep into speculating on property, a main driver of the surging prices that have Chinese authorities worried that a bubble might be forming.”

It is still an open question regarding how long the situation can continue and how badly this speculative cycle will end. There is still a huge demand for housing in China, this has to be countered with the huge price increases and questionable credit practices for personal housing loans.

Housing market, risk surge in China
http://www.newsobserver.com/business/story/795070.html

ETF to Short China

For those who believe that the Chinese stock market is a bubble, there is now an easy way to take action on your convictions. The UltraShort FTSE/Xinhua China 25 ProShare (FXP) moves twice in the opposite direction of the Chinese stock market. The underlying index is the FTSE/Xinhua China 25 Index.

Doubling down on a global downturn
ProShares funds short booming Chinese stocks, other emerging markets
http://www.marketwatch.com/news/story/new-etf-lets-investors-profit/story.aspx?guid=%7B225CDEB1%2DACBD%2D4A6D%2D84CD%2DADF393307D9F%7D&dist=TNMostMailed

Name the company with the largest Market Cap?

Thinking Exxon (XOM) at $488B? Try again. PetroChina tripled on its first day of trading in Shanghai becoming the world’s first company to be valued at $1 Trillion.

PetroChina's Value Tops $1 Trillion, Surpassing Exxon
http://www.bloomberg.com/apps/news?pid=20601087&sid=afq.WPd_zCO4&refer=home

Rising Tide: Chinese IPOs

Investors still have a strong appetite Chinese IPOs. Another slew of Chinese IPOs are arriving on U.S. exchanges this week. Longtop Financial Technologies Ltd. and jewelry maker Fuqi International Inc. will begin trading this week. In other recent news, Chinese games developer Giant Interactive selected the New York Stock Exchange for its $801m offering, the largest initial public offering in the U.S. by a Chinese company since 1999.

At the same time the government of China is preparing large state enterprises for listing. While earlier there has been speculation over the offering of large state firms on exchanges, recent news last week makes the plans more concrete. Beijing is preparing thirty “national champions” controlled by the central government for initial public offerings, most likely before 2010. A list of 30 candidates was revealed last Tuesday in Chinese newspapers. It includes leading companies in several strategically important industries such as metals processing (China Minmetals), nuclear energy (China National Nuclear Corp), aviation (China National Aviation Holding Company), and power equipment (Dongfang Electric).

It is not clear what the division of ownership will be among the mainland exchanges, Hong Kong, and foreign markets; nor what ownership privileges will be assigned to classes of shares.

This is coupled with the news that PetroChina, China's biggest oil and gas producer, is settling on pricing for an initial public offering in Shanghai that is expected to raise nearly $10B. There is an increasing trend among Chinese companies that are already listed in foreign markets and Hong Kong to return to domestic exchanges for further sizable offerings. This demonstrates the strength and maturity of the mainland Chinese markets.

With an economy that is still growing at over 10% per year, it is not clear how long the IPO trend will continue, or if fears about a Chinese investment bubble are properly founded.

China Readies Large State Enterprises For Listing
http://www.forbes.com/markets/2007/10/16/china-soe-listings-markets-equity-cx_jc_1016markets01.html?feed=rss_markets

PetroChina Begins Consultations on IPO
http://biz.yahoo.com/ap/071022/china_petrochina.html?.v=3

IPO Spotlight: Chinese Companies Heat Up
http://biz.yahoo.com/ap/071022/ipo_spotlight_longtop_financial.html?.v=1

NYSE wins $800m Chinese IPO
http://www.financialnews-us.com/index.cfm?page=ushome&contentid=2449001138&uid=8907-2510-832401-522848

China - Sticking to the Game Plan

China still appears to be sticking with their game plan regarding the pegging of the Yuan to the Dollar in a tight fixed range, despite inflationary and other pressures on their economy. From a distant perspective, the Chinese government is being very wise in their policy which is built around:

• Diversifying over time from the Dollar to other currencies to reflect the overall allocation of trade with their nation. More reserves will be held in Euros, Pounds, etc. This reduces currency fluctuation risk.
• Purchasing other assets beside U.S. government bonds. The recent purchases have included private equity funds, stocks, bonds of other nations, and real estate. These moves increase the return on the reserves while diversifying the risk from a single type of instrument (U.S. treasuries and bonds).
• Maintaining the peg of the Yuan to the Dollar in a tight range. This eliminates the risk of major moves in the currency market from impacting the Chinese economy. This implies that the government will not have external Forex traders and hedge funds dictate their future. Strict control is maintained over the peg preventing foreign currency market arbitrage plays that would cause a run on the Yuan with associated economic devastation.
• Cleaning up the banks in China. Many banks have bad debt with poor controls and the government has taken steps to clean up the mess including foreign ownership of some banking assets to reduce risk. One primary reason for the currency peg was to protect the banks that were on shaky structural ground. This provided the government with time to clean up the mess and align the banks with western financial standards.

The downside of the government policy in regards to the peg is the friction with trade partners and inflationary pressure associated with runaway growth. During the past year interest rates were raised several times in an attempt the cool the economy, and other measures were implemented to reduce lending. However at this point the overall game plan has worked out well for China over the past few years. The question will be can they stick to the plan in the upcoming months.

Yuan, Rupee Rise at Record Pace in Fight on Inflation
http://www.bloomberg.com/apps/news?pid=20601068&sid=avCQ7I4bVhmo&refer=economy

Chinese Stock Market Uncorrelated with World Markets – Is it the new Safe Haven?

First, let’s take a look at the performance of the Shanghai Index compared to the US indexes over the past 6 months.
http://finance.yahoo.com/q/bc?t=6m&s=000001.SS&l=off&z=m&q=l&c=&c=%5EGSPC&c=%5EIXIC&c=%5EDJI

Despite earlier thoughts that the Chinese market had topped and shortly would implode; the Shanghai Index appears to be driving towards new heights. The robust growth in China’s economy and inflow of cash from new investors is driving the internal stock market. The situation appears to still be a “bubble”; the question being how much more can it inflate.

One interesting note is that the Chinese stock market from a correlation perspective is the least correlated with world-wide markets. On days the Chinese markets go up, the world markets are down… and visa-versa. The lack of correlation to the outside markets makes the Chinese market a potential safe haven as a component in a diversified portfolio. Straight-forward math in Modern Portfolio Theory (MPT) would indicate that people should have some component of their stock portfolio be Chinese indexes from a safety perspective.

The economic policies of the Chinese government isolate their stock markets from much of the outside risk. The implementation of yuan currency range setting, limiting monetary inflows/outflows, and limitations on external investment shield the Chinese stock market from some of the external excesses that are now becoming apparent in the credit liquidity crisis.

This is an interesting situation. The concept that a foreign stock market that many believe is in a bubble could potentially be a safe haven… may rewrite the concept of how risk should be evaluated in the financial markets.

Shanghai Index Double Top

It certainly appears that the Shanghai Index has formed a traditional double top. The first top being the peak, and the second top being an unsuccessful attempt to drive beyond the original peak. The index is now down 13% from its height and appears to be diving through the support level.

http://finance.yahoo.com/q/bc?s=000001.SS&t=6m&l=off&z=m&q=l&c

Not a compelling technical picture for any bulls touting the Chinese market. I expect the situation will only go downhill from here.

The Plunge Continues - China

The rest of the world markets yawn as Chinese speculative bubble continues its plunge. Most global markets opened either flat or slightly down....

Chinese Stocks Take Big Fall
Chinese Stocks Tumble 8.3 Percent, Biggest Daily Drop Since February Plunge

BEIJING (AP) -- Chinese stocks plunged Monday following government efforts to cool a market boom, recording their biggest one-day fall since a February drop that triggered a global sell-off.

The benchmark Shanghai Composite Index tumbled 8.3 percent to 3,670.40, falling for the third time in four sessions since the government raised a tax on trading last week. The index had dropped 2.7 percent Friday. The Shenzhen Composite Index for China's smaller second market fell 7.9 percent to 1,039.90.

http://biz.yahoo.com/ap/070604/china_markets.html?.v=6

"There is the risk that this snowballs into a crash. Sentiment is so fevered that a bubble could burst," said Claire Innes, an economist in London with the consulting firm Global Insight.

Chinese Market Plunges - barely causes a ripple outside of China

The recent correction of the Chinese markets today barely caused a ripple in stock markets outside of China. The main Shanghai Composite Index tumbled 6.5 percent to 4,071.27 Wednesday. The Shenzhen Composite Index for China's smaller second market fell even more, closing down 7.2 percent at 1,199.45. Most of the other world indexes closed up by more then 0.7% on average in response; largely ignoring the Chinese market plunge. This is another sign that the stock market bubble in China is irrelevant to the rest of the world. The stock market in China represents only a small fraction of the overall worldwide markets and the overall capitalization is minuscule on a comparative basis.

From a big picture perspective, the combined capitalization of the Chinese stock markets was US$786b at the end of 2006. The total for all the global equity markets is over $33Trillion; the NYSE alone is at over $23T (Sept 2006). The US represents over 1/2 of the global equity markets capitalization.

The Chinese government holds over $1.2T foreign reserves, and are increasing these reserves at over $12B per month. The Chinese product exports (not overall trade) are now at over $1.2T per year. While the Chinese national gross GDP was at about $2.6T; compared to the US at about $13.2T (notice that the US stock market capitalization is 2x bigger then the national GDP).

The size of the Chinese stock market is a small percentage (2.3% at best) of the overall world-wide equity markets (ignoring the size of the futures, commodities, options, bond, debt, and other markets), and just a fraction of the Chinese foreign reserves or export trade size. The overall stock market capitalization places the country in a distant sixth place slot for overall national equity market size. The stock market capitalization in China represents a mere 60% of their GDP.

From the math, the stock market is an insignificant (and non-critical) component of the overall Chinese economy. This minimizes the risk that a meltdown in the Chinese stock market would have any international impact.

From a broader economic perspective, most analysts expect the sizzling economic growth in China to slow a bit because the government is deliberately tapping the brakes. Most do not expect the slowdown to be very significant despite these efforts. There is still a huge demand in China for building materials, energy, raw materials, etc.... and the economy is still growing at greater then 9% per year. The economy in China remains strong.

The stock market situation in China however is another story. The local equity markets are in a speculative bubble that is doomed to burst; the question is when rather then if. The good news is that the size and capitalization of these stock markets are insignificant from a global perspective. The bad news is that the bubble pop will take a lot of unknowledgeable individual investors located in China down with it.

One recent article also looked at the Chinese market situation:
Greenspan's China-Stock `Contraction' May Not Spread
http://www.bloomberg.com/apps/news?pid=20601087&sid=aQ281g_cfnWI&refer=home

Some quotes:

"That's the conclusion of a number of international economists and former government officials around the globe. They say China's economy shows little correlation with its stock market, foreigners are mostly excluded from owning shares and Chinese participation is limited to less than 10 percent of the population, reducing the effect of a bursting bubble."

``This is a relatively small casino,'' said Edwin Truman, a former director of the Federal Reserve's international finance division and now a senior fellow at the Peterson Institute for International Economics in Washington. ``Even the implications for the Chinese economy should be minor.''

"Total stock holdings in China account for just 25 percent of domestic wealth, and in Asia only Indonesia has a smaller market capitalization than China's 60 percent of GDP."

So in summary, the Chinese stock market melting down (which is likely to happen) is a non-issue from an international perspective; the Chinese economy having issues would be another story.