The China 'Bubble': Buy, Sell, Or Hold? 33 comments
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There's no question that the Shanghai Composite ($SSEC) has had quite a run since bottoming out in November 2008. The Index is up over 100% from its trough (see weekly chart below) and is up almost 40% since May (see daily chart below).
Is This Really a Bubble?
Everyone is talking about a Chinese stock market "bubble" these days and I'd be lying if I said that I couldn't see the bubble inflating. However, if the last 12 months has taught me anything, it's that markets tend to be in an irrational state more often than not...and that it's nearly impossible to know when the sanity will return. That's why I try to leave my emotions out of it and just follow the trend.
Identifying a trend is much easier than anticipating when that trend will end. I know it's hard to stick with a trade (or enter a new one) after a big run-up like we've seen in the Shanghai Composite, but sticking with the trend is usually the higher probability trade. Many traders try to time market tops and bottoms...but I've yet to meet one that has done so consistently. Fighting the trend is a losing proposition, in my opinion.
The Value of Knowing When Not to Trade
That being said, if you don't want to get long China right now, you're probably better off standing aside. Most traders and investors tend to underestimate the value of "standing aside". Knowing when not to trade is just as important as knowing when to buy or sell.
Don't get caught up in the hype of trying to time the Chinese bubble bursting. There are better reward-to-risk trades out there...
Bubble Risk Management: The Parabolic Stop
It's been my experience that the reward-to-risk ratio decreases exponentially when the velocity of a trend increases. It's not so much that the potential reward (numerator) is decreasing (often times the potential reward will increase as the trend picks up steam)...it's that the potential risk (denominator) tends to increase at a faster pace due to the increased uncertainty associated with a potential violent pullback in the opposite direction.
This is why many of my strategies include a "parabolic" stop loss that gets tighter as a market moves in a favorable direction. A parabolic stop allows you to keep your reward-to-risk ratio in line.
To illustrate my point, below is the daily Shanghai Composite chart again (this time including Wells Wilder's Parabolic SAR). Notice how the distance between the price and the indicator shrinks as the recent move picks up steam.
Disclosure: No positions
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Some sober facts:
1. China is a communist country ruled by 1 party with iron grip. Party bosses pick the politicians and many private company managements since many private companies are ex-SOE (communist state owned enterprises).
2. Corruption in China is rampant and one of the worst even down to lower ranking employees. Even factory canteen chef gets "envelopes" in scheme where he claims he received 10 bags of rice when only 8 bags are delivered.
3. There is almost no "law" since law itself is written to support the communist party or corrupt local communist bosses. Judges are appointed by the local communist boss and few if any understand law. Many judges got job thru "guanxi" or connection and of course bribes.
4. The Chinese banks in are BIG TROUBLE. E&Y got in heaps of trouble for discussing hidden bad and uncollectible debts. Local communist cadres dictate banks to lend to their pet projects and of course friends who bribe them not to mention COMPLETE lack of transparency.
5. No one except pea size brains trusts the communist government's statistics which are MANIPULATED.
6. Many of the listed companies numbers are COOKED. Auditors and their management can be bribed and extorted. It's beyond me how anyone would trust Chinese companies' financials unless audited by Big 4. And even Big 4s audited numbers are suspect since most Chinese companies carry multiple books including one for taxation and another for real book with slush funds.
7. Latest Chinese share and commodity appreciation have lot to do with communists pumping money to the economy by directing the banks to make loans. This kind of stimulus cannot go on.
Now is good time to buy FXP when all the investment gurus in unison are recommending Chinese stocks.
MONDAY, JULY 27, 2009
The Four Cheapest Plays in Emerging Markets
When we spoke earlier this month, you mentioned that you were bullish on China short term, but much less so over the long term. Is that still the case?
I've changed my mind since we last spoke. We are negative on China short term as well. The reason is that the stimulus package there has been absolutely massive. As a percentage of GDP, it is three or four times the size of the U.S. stimulus. In this year alone, they've had new loans worth over $1 trillion, of which more than $250 billion was issued in June. It is massive.
What's your biggest concern about that?
I believe that a lot of this money is not going into productive investment. What we are hearing anecdotally is that a lot is being lent by the banks, which, remember, are government-owned. Who are they lending to? For the most part, this money is going to state-owned enterprises, which are not particularly efficient companies.
We know that they are buying real estate, and they are doing all kinds of things that we don't think in the long run is particularly productive investment. Now, in the short run, the stimulus works, because it puts money in the hands of people who are buying and consuming stuff. So therefore, car sales in China hit an all-time record last month.
What will be the consequences in China?
Two things are likely to happen. First, longer term, if the banks don't have a problem with bad loans now, they will almost certainly have a lot more bad loans two or three years from now. Second, from a short-term point of view, at some point the government is going to get really worried about having too much credit-creation; that leads to a credit bubble, just like you had in this country and everywhere else. As a result, they will start to withdraw liquidity by tightening the gates on money. I don't know when that will be. But I worry that it is coming.
A fair amount of the stimulus money has found its way into the real-estate and stock markets because China has a closed economy. So there is no way for money to leave the country. The stock market and real estate have had huge spikes. So when that liquidity is withdrawn, it seems inevitable that the stock market will take it badly.
minyanville.com/ar...
Why China Won't Save the Day
If I told you the next US stimulus package would be $4.5 trillion dollars, mostly given to banks that would be forced to loan out the money quickly, do you think that might jump spending and GDP in the short term? Would you start looking for a few bubbles to be created? What about the dollar?
That’s the equivalent of what China’s now doing. The volume of credit that’s flowing into the country is equivalent to one-third of their GDP. Banks that already have large problem-loan portfolios are now lending even more, in a very short time frame. China has severe capacity-utilization problems, as trade has sharply fallen; and the US consumer is unlikely to return to anywhere near the level of consumption that was the case in 2006.
The Chinese stock market is up 85% this year, and commodity and real estate prices are rising. And no wonder: The money supply shot up 28.5% in June alone. That money is looking for a home. My friend Vitaliy Katsenelson has written a very perceptive essay for Foreign Policy magazine, talking about the nature of the current growth in China.
"But don't confuse fast growth with sustainable growth. Much of China's growth over the past decade has come from lending to the United States. The country suffers from real overcapacity. And now growth comes from borrowing -- and hundreds of billion-dollar decisions made on the fly don't inspire a lot of confidence. For example, a nearly completed, 13-story building in Shanghai collapsed in June due to the poor quality of its construction.
"This growth will result in a huge pile of bad debt -- as forced lending is bad lending. The list of negative consequences is very long, but the bottom line is simple: There is no miracle in the Chinese miracle growth, and China will pay a price. The only question is when and how much."
I’m going to quote at some length from Simon Hunt's latest note. He travels very frequently to China and is one of the world's true experts on the copper market. Copper, we’re told, is the metal with a PhD in economics. If copper prices are rising, then the economy is booming. And historically, that’s more or less been the case. But there may be reason to believe that a PhD may be no more useful this time around than a regular Ivy League degree.
Only decent "natural resource" China has is coal with atrocious disregard for safety resulting in literally thousands of death per year. Article below states almost 6k lives were lost in 1 year.
www.china-labour.org.h...
.
Here's a good read: "Rich China, Poor Peasant"
online.wsj.com/article...
And "The Dark Side of Chinese Manufacturing"
seekingalpha.com/insta...
I recall visiting a plastic lid company near GuongZhou in 1998. There were about 150 women (either 12 to 15 or over 55) crouched down on tiny stool hand painting McD kid's meal toys out in the sun on a cramped courtyard each with a wash basin filled with paint and brushes.
Another was famous HonHai's Foxconn cable factory in Shenzhen 7 years ago. There were no space between workers sitting on a stool with conveyor moving in high speed with boss watching over them. Each end of the factory floor has bathroom with very strong raw human waste that the factory boss joked that new and poor performing workers sit there.
There were often stories of young female worker suicides which occurred often enough that local press stop reporting (also factory boss paid off the press so as not to scare the workers).
More recent trend I noticed is that the production line is about half men and older women as it was mostly young migrant women before 2005. This is due to bizarre 1-child policy and latest government stat is 115:100 when reality may be closer to 120:100. Historically such imbalance resulted in war bringing the balance back as well as wealth or land grabbed. My prediction is war between USA and China in next 5 to 10 years.
On Jul 28 01:55 PM Sober Realist wrote:
> What's not to like about investing in a ruthless dictatorship that
> hoards all the wealth generated off the backs of its its dirt cheap
> labor pool?
> Here's a good read: "Rich China, Poor Peasant"
> online.wsj.com/article...
>
>
> And "The Dark Side of Chinese Manufacturing"
> seekingalpha.com/insta...
Anything more current?
RE: the War aspect. agree on that, my feeling is that it will be closer though, say, 3-5 years.
www.youtube.com/watch?...
In one part of the film a college student is looking for work and he's scouring a job post bulletin board. He has to pay 200 yuan if he wants to apply for one of the listings. The only problem is that the job posting could be fake and he won't get his money back.
---According to another poster on the Michael Pettis website, these fake job advertisements in China are widespread.
Han Dongfang is also in this video. He was jailed without trial for 2 years and then banned from mainland China. He resides in Hong Kong now. "He says that no one is standing on the (Chinese) workers side. It's just sick."
The interviewer tells Dongfang that "We(the West) always hear that China is a modern country and the workers have never been better off than they are now."
Dongfang replies," We didn't hear that. We all know that (Chinese) workers are working in one of the worst situations and the worker's rights is one of the worst in the world. We never heard that workers in China were better off."
Wake up America! Those singing the praises of this dictatorship are deluded.
2 of 3 links (Barron's and Maudlin) came out in last few days and 3rd link of deplorable Chinese coal mine fatalities are from 2003. Nevertheless any recent government data tend to undercount who perish on the illegal coal mines.
Here is direct link to Barron's (require subscription):
MONDAY, JULY 27, 2009
INTERVIEW
The Four Cheapest Plays in Emerging Markets
Arjun Divecha, Portfolio Manager, GMO Emerging Markets III Fund
By LAWRENCE C. STRAUSS | MORE ARTICLES BY AUTHOR
AN INTERVIEW WITH ARJUN DIVECHA: Choosing the right emerging market.
online.barrons.com/art...
How about Helping India's poor, Zimbabwe, Nigeria, or North Korea.
Yeah, Lets help North Korea. If we help them, they will look up to us.
Or Iran and Venezuela, they could use a handout too.
But closer to Home, how about Asking Mexico to send us their poor. Lets send trucks to bring them in, cloth and, feed and provide Health Care.
That will surely change the way the Government in Mexico works.
They will not ask for handouts, Bribes or gifts anymore.
Instead of Trying to help the Downtrodden in China, How about a Little help for the Unemployed in the "Lets right the wrongs in the rest of the World." USA
I couldn't care less about the Rest of the World.
I'm about to use the last of my Unemployment checks, How about a little Help Here.
Chinese will try to meddle and outright bully USA in next few years with veiled threats of liquidating or not buying US debt and one of few recourse for USA may be to whip China over small military dispute.
Some reasons:
1. It is US's interest to continue to dominate the world order. US managed to break down USSR and won wars against rising unfriendly rising powers like Japan and Germany. Japan in particular challenged the presence of US and Europeans in Asia. No other countries other than China and Russia can challenge US dominance now or foreseeable future.
2. China in newly found nationalism is exerting its power. China is US's biggest debtor and has rights to demand how their money is spent. China loaned US money so US consumers will buy the cheap goods. This trend has changed and pace of foreign reserve will dwindle due to slowing export market.
China also faces severe male/female ratio due to 1 child policy and history shows that such imbalance results in war. Too many angry testesorone charged males will either cause trouble at home or better sent to fight a war and bring some war booties back.
3. China will try to influence US politics and economy and why not as the biggest debtor? All they have to do is pull the money out literally destroy our USD. US will not yield to suck blackmail.
4. War against China will be limited air/sea affair and US can and will teach them a lesson or 2. Japan, South Kore and neighboring countries like Vietnam and India will be on US side.
China will be whipped by US forces with overwhelming prowess and naval blockade. Chinese forces have not seen any combat since late 70's Vietnamese invasion which was disastrous defeat for them. Most conscripts and officers are bunch of sole spoiled mama's boys. Their parents will encourage them to surrender to save the family lineage than to fight. US forces are well greased fighting machines from current wars in middle east. Chinese communist leaders will try to save face by ending this limited war and US will demand that Chinese forgive the debt.
Far fetched? Not really as I see this happening in next 5 to 10 years.
Remember that we came out of Depression thanks to World War II.
This is not, of course, a "buy and hold" situation; but anyone who knows how to place stop-loss orders can profit in this kind of market, whether you call it a bubble, a rally, or a bull. So why shouldn't you?
Do something for the people in the "tent" cities.
I'm tired of "Do-Gooders" trying to fix the Rest of the World.
If you want to do some Good, fix America first.
Yes, there are deplorable conditions still in many parts of China with many horrible business paractices. People forget that China is an EMERGING market. When the US was an emerging market decades ago, the working and business conditions were not so good either.
But China is making unbelievably rapid progress and will be THE economic power in the not-so-distant future.
Not investing in China today is like those European investors in the late 1800s who fluffed off that emerging market - the US - as too wild and not investible.
"Globalisation has made corporations very rich at a huge cost to the western consumer. Now that all the piece good jobs have been exported the tertiary manufacturing of most Western countries has all but disappeared. Western economies have been turned into service economies with only Mc Jobs to offer. Everyone will attest to the declining quality of goods carrying brand names such as HP, Toshiba, DeWalt ,Stanley, G.E etc: with retail prices just marginally less than they would have been were they manufactured domestically, the profits to the distributors are massive. China has always had a quality problem but has offset it by price and to a large extent the brand manufacturers have been complacent because profits are so high.
If China wants to have a proper economy then it has to generate its own consumers, have fair working practices, a fair legal system, an end to sweatshop labour, and a decent social system and a proper distribution of wealth. This will take many years but what exists now is reminiscent of the cotton mills and mines of 19th century Britain. That will blow up in their faces very soon and then we will see a situation reminiscent of Britain in the 50's ad 60's where there was a total absence of reliability or quality, or a return to hard line communism. "
On Jul 28 03:25 PM harammph wrote:
> Typical American Arrogance: Do as we Do.
>
> How about Helping India's poor, Zimbabwe, Nigeria, or North Korea.
>
>
> Yeah, Lets help North Korea. If we help them, they will look up to
> us.
> Or Iran and Venezuela, they could use a handout too.
>
> But closer to Home, how about Asking Mexico to send us their poor.
> Lets send trucks to bring them in, cloth and, feed and provide Health
> Care.
>
> That will surely change the way the Government in Mexico works.<br/>They
> will not ask for handouts, Bribes or gifts anymore.
>
> Instead of Trying to help the Downtrodden in China, How about a Little
> help for the Unemployed in the "Lets right the wrongs in the rest
> of the World." USA
>
> I couldn't care less about the Rest of the World.
>
> I'm about to use the last of my Unemployment checks, How about a
> little Help Here.
www.businessweek.com/g...
Shanghai Stock Market: Bubble Days are here again
Posted by: Frederik Balfour on July 29
How do you spell stock market bubble? S-H-A-N-G-H-A-I. China’s main share market is up 90% this year, and some IPOs are skyrockets several times their offer price on the first day of trading. Sichuan Expressway soared 300%, repeat 300% on its opening day of trading on Monday July 27, and China State Construction Engineering Corporation surged 70% today, July 29, even as the Shanghai Stock Index plunged 5%. Of course that might just be due to a sell-off in most other stocks so people could climb onto the IPO bandwagon. Chinese investors routinely liquidate existing positions to pile into new issues.
But let’s face it, Pigs Don’t Fly, not even in China. The febrile enthusiasm exhibited by Chinese investors in this latest market rally, shows that nothing was learned from the market rout that started in late 2007. If anything, people are desperate to plough back into the stock market to make up for previous losses. In China, the risk of missing a rally is more important to many punters than the potential downside should there be a correction. See my story Suckers Rally. Oh, and let’s not forget to mention that Shanghai has overtaken Japan as the world’s second largest stock market.
It’s important to remember that China’s stock market is still something of a black box. The China Securities Regulatory Commission’s vetting process of IPOs is anything but transparent, and you can bet that when there’s so much money to be made from listings, that corruption is inevitable. There’s a long list of firms in the queue to IPO, and the CRSC gets to decide who goes and who waits. One can well imagine how companies are willing to grease the wheels of bureaucracy to tap markets at a time like this when things are so hot. “They need listing rules to be more transparent and standardized so companies don’t have to kowtow and lobby [to the CSRC] the head of investment banking in China at an international bank told me a few weeks ago.
How long the current rally will last is anyone’s guess. Valuations are already nearly as high as they were when the last bubble burst. But with Beijing encouraging banks to pump money into the economy—lending was up more than 200% year on year in the first six months—much of this money will find its way into the stock market, regardless of what purpose for which it was originally borrowed.
This is a can't lose situation here and across India. There is so much stimulus at work here it is crazy. For new businesses and expansions there are many tax free zones through out the country where no taxes are paid to the Govt. for ten years. For every sales dollar the business charges the customer the dollar plus 24% in taxes, the businesses pocket the 24% because of the stimulus incentive. 24% EBIT on every dollar of sales not to shabby and that does not include the normal profitability.
There may be a bubble in China but not not in India. I agree with Jasper M. that the only long play in my opinion is India!!