China's Stock Mania: The End is Near

Dip into the historical accounts of financial manias in classics like Extraordinary Popular Delusions and the Madness of Crowds, or even more contemporary accounts like Devil Take The Hindmost: A History of Financial Speculation, and you are struck by one thing. The collective psychology of financial manias remain remarkably similar, no matter the time or place. The French were right: Plus ca change, plus ces't la meme chose. "The more things change, the more they stay the same."

The current stock market mania in China's mainland has as much in common with the Tulipmania of the 17th century, as it does with the Internet boom of the late 1990s. In particular, the run-up of the Shanghai index is remarkably similar to the recent meteoric rise and collapse of the Arab markets -- down 70% since February 2006. Both took root in a country that had little or no experience with a stock market. And, a "this time it's different" atmosphere pervaded, a set of new fangled heroes drew in millions of unsuspecting small investors, and those who came late to the party ended up suffering devastating losses after the inevitable crash. Like the Arab markets, the Shanghai market is closed to foreign investors. But as the 9% drop in the Shanghai index on Feb. 27 shows, unlike the collapse in the Middle East, the impact of the Shanghai swoon can be felt all the way to Wall Street.

Even the biggest China Bulls around admit that China is in a bubble. The Shanghai Composite Index is now approaching 4,000 -- a rise of nearly 40% so far this year after a 130% increase in 2006. The Shanghai and Shenzhen exchanges now have a market cap of about 15 trillion yuan ($1.8 trillion). While that doesn't make it a big market globally -- the New York Stock Exchange had a total capitalization of $26.5 trillion as of Dec. 31 -- China's market places second in Asia, behind Japan, after surpassing Hong Kong just last month.

China's Stock Mania: "Like a casino set up by the Communist Party"

Anecdotal accounts of China's current mania are distressingly familiar. Investors are queuing to open accounts at local securities houses, as applications are five times as high as a year ago. Students and pensioners crowd around computer terminals watching ticker signs go by. A self-appointed "stock god" like Lin Yuan lectures hundreds at Peking University to reveal his secrets on how he has made some 400 million yuan ($52 million) in the market. One out of three university students in China is playing the markets.

New technology -- Internet and mobile telephony -- has only exacerbated the mania. Broadband penetration means that housewives, pensioners and students all are on the same playing field. Many employees spend their workday trading through e-mails and instant messaging. Companies have introduced fines to deter employees from spending their time trading stocks online. It has all been in vain. Mobile-telephone users trade shares simply by pressing buttons on their handsets.

There are now more than 91 million accounts held by individuals at brokerages or in mutual funds. About 10% of these accounts were opened in just the first three months of this year -- and 10 times as many accounts were opened in first quarter 2006 as for all of 2005. Online trading is spreading rapidly, and in recent weeks individuals have been opening stock-trading accounts at the rate of about 90,000 per day -- 35 times the pace of a year earlier.

Since China doesn't permit brokers to offer margin trading, China's stock market newbies have started pawning personal assets to invest in shares. Some are pledging their homes as collateral for personal loans. Beijing residents last year pawned houses valued at 1.5 billion yuan ($195 million), much of it in order to buy shares. Pawnshops in Shanghai confirmed that their business was now dominated by loans against apartments to fund stock buys. Like the merchants who sold picks and shovels to prospectors in the California Gold Rush, it sure is good business. The pawnshops charge a monthly interest rate of 2.5-3% for loans backed by apartments. One pawnshop even has taken out advertising space on taxi windows.

China's Stock Mania: What is To Be Done?

Few of today's speculators recall that this is China's second stock market mania. In the first three years after stock trading began in China during 1990, the Shanghai index jumped six-fold. Trading got so heated that riots broke out among people hoping to get in on initial public offerings. The stock market became a playground for manipulation and scandal throughout the 1990s. The market drifted into virtual irrelevance, before it came back to life at the end of 2005.

Today, the Shanghai market may have already peaked. The bottom has already dropped out of the markets twice this year -- on Feb. 27 and April 19 -- on the back of rumors of a government crackdown. China's leaders are worried, but essentially helpless. Local players have ignored interest-rate rises and increases in banks' reserve requirements. And there's little the government can do to control the Chinese obsession with gambling. It's no surprise that the same year that Shanghai more than doubled, the casinos in Macao recorded higher revenues than the Las Vegas Strip.

Here's my prediction. The China stock mania will end in tears -- as has every other stock market mania in history. Indeed, place the long-term charts of the Shanghai index alongside the NASDAQ, and the patterns are eerily similar. The Chinese authorities will try to intervene -- unsuccessfully. And when the bubble pops, the negative effects will be profound. Students and pensioners stayed on the sidelines last time around. This time, they will be the most affected. If tens of millions of urban Chinese lose their shirts, they'll be looking to the government to bail them out -- or else, they will turn very angry. Not even Chinese mandarins have power over the laws of financial speculation.

Comments

[David Lentz:]

How about following through on what options the "Chinese mandarins" will have to quell the rising public dissatisfaction when the bubble pops? Who owes the the Chinese lots and lots of money, and how can the Chinese rulers leverage this debt to shower rewards on the murmuring masses who have been shown the dark side of capitalism?

2007 Apr 30 07:16 AM

[Scotfree:]

So the Chinese mania will end in tears? What's bold about that prediction? What would be bold is predicting when it will end. Alan Greenspan was right about "irrational exhuberance," but the markets sailed on for another two years. One thing you didn't factor in: The last thing the Chinese authorities want is a market crash on the eve of the 2008 Olympics.

2007 Apr 30 10:37 AM

[Chimin Sang:]

So they want the bubble burst way before 2008 Olympics.

2007 Apr 30 11:46 AM

[Lei Yang:]

How near is 'near'?

2007 Apr 30 10:50 AM

[huangjin:]

The U.S. Fed killed the party when they raised interest rates. The Chinese are in the process of raising rates and raising reserve requirements; it's only a matter of when inflation scares the crap out of the PBOC and they overshoot. Right now they're still under the delusion that they can control the economy. They have been trying to slow growth for 4 straight years now, with no effect. Since the country can cover their tracks with bad CPI data (and GDP growth, and non-performing loans, and...) for awhile, they can prolong the inevitable. But the inevitable always comes. The longer the wait, the bigger the fall.

2007 Apr 30 05:34 PM

[John Gaats:]

It is hard to say any stock market that is free of stock mania. From time to time. From big mania to small mania. There is also selective chasing within the mania. In general, they over value their stocks because they don't have access to our stocks. In our markets, Asian ADRs are generally under valued. For example, DCX is more popular than TM. I call this a buyout mania.

Having said that, I sensed fear in the market these days. Good stocks are under valued. We have witnessed big drop from MHS to WGS to POT. The drop happen when they report good earnings. I call this fear mania.

The long and short is that we have our mania and they have theirs. I don't know whats going to happen when investors seek mania free. When we exagerate Chinese mania. Don't forget our mania. Stock markets are never good reflectors of real economy. Stock related blogs are even less. I hope we don't try to hurt others and end up hurting our own investments.

2007 May 01 11:18 AM

[rlirph:]

How near is near? If the Chinese stock market opens tomorrow 30% down, does it mean the bubble has bursted? Just because it happened before some where does not mean that it will happen in the same manner or form.

There is a big difference between the US Internet bubble and the Chinese market now. The US companies were making little money resulting in over 1000 PE ratios for AOL, EBay, JDSU etc. The Chinese companies are actually reasonably priced if you consider that their earnings went up 45% from last year
(that is from over 1400 public companies reported 1Q 2007 to date). Would you not buy a stock with a PE of 40 if their earning growth is 45%?

2007 May 07 08:00 AM

[andykleung:]

A more interesting point would be how profits can be made if the Chinese market will sink...any suugestions?

2007 May 08 10:43 AM