'Pao Mo': That's Chinese for Bubble

Includes: FXI, PGJ
by: Michael Panzner

Perhaps it has just reached a tipping point. That is, the suddenly widespread belief that there is a stock market "bubble" in China (or, as I'm told the locals themselves might refer to it, a "pao mo"). No doubt a report that former Federal Reserve Chairman Alan Greenspan feared a "dramatic contraction" in Chinese share prices, together with the lack of any real breakthroughs on trade during a recent visit by Vice Premier Wu Yi, has helped stoke a popular interest in all sorts of Chinese financial matters.

Regardless, it must surely be a sign that this particular bubble (as opposed to the ones in the private equity market, the derivatives market, the bond market, the art market, the hedge fund sector, and elsewhere) is about to burst when three top business news organizations publish reports on the same day describing the insanity that has been unfolding for quite some time now on the other side of the world.

"China's Investors Pay Little Heed to Greenspan" (via Bloomberg):

China's individual investors, who ignored warnings of a bubble by Asia's richest man Li Ka-shing and central bank Governor Zhou Xiaochuan, gave Alan Greenspan short shrift, too.

The CSI 300 Index fell less than half a percentage point today after former Federal Reserve Chairman Greenspan said gains are unsustainable and the market may undergo a "dramatic contraction." The benchmark has jumped 92 percent this year after more than doubling in 2006.

"Their comments are just like throwing small pieces of ice into boiling water, which won't cool down at all," said Wang Qing, 36, a full-time investor since leaving his job as a consultancy manager in Shanghai last year. "The investment mania is still going on."

China's stocks are the most expensive among the world's major markets after a rally that's drawn record numbers of investors. The number of brokerage accounts topped 99 million this year, with more than 300,000 opened daily. Students, pensioners and maids -- many with scant investment knowledge -- are among those who are using their savings and even living expenses to play the market, according to Chinese media reports.

"It's easier to make money from stock investment than work nowadays," said Hang Ming, 28, one of about 15 cooks from a local restaurant who were tracking stock prices at the Shenyin & Wanguo Securities Co. brokerage in Shanghai's Lujiazui district today. "There's risk, just like in playing mahjong, but I don't care."

'Everyone Makes Money'

The CSI 300 trades at 45 times earnings, triple the ratio for the Morgan Stanley Capital International Emerging Markets Index. Japan's Nikkei-225 Stock Average trades at 23 times earnings, Hong Kong's Hang Seng Index is at 16 times, and the U.S. S&P 500 Index is on a multiple of 18.

"It is clearly unsustainable," Greenspan told a conference in Madrid yesterday by satellite. "There is going to be a dramatic contraction at some point."

China's stock regulator today ordered brokerages to make investors sign a declaration that they are aware of the risks when opening stock-trading accounts, a reflection of official concern at the growing numbers of inexperienced investors.

The CSI Index reached new records this week after Hong Kong billionaire Li said on May 18 that the market "must be a bubble." It's added 10 percent since May 6, when the central bank's Zhou said he was concerned about valuations. The index closed 0.49 percent lower today after swinging between gains and losses.

"China is still a market that's not quite in line with international practice, so I wouldn't care too much about Greenspan," said Wu Ruiling, 68, a retired teacher.

Chinese stocks trading in the U.S. fell yesterday after Greenspan's comments. Today, the Bank of New York Co.'s China ADR Index slid for a third day, losing 1.9 percent to 364.07 at 11:56 a.m. in New York. The index reached a record on May 21.

Earnings Growth

Wu said she's made a 60 percent return on her 500,000 yuan ($65,344) investment, buying shares such as Shenzhen Development Bank Co., controlled by buyout firm TPG. Shenzhen Bank shares have jumped 247 percent in the past year.

The rally has been driven by expectations that annual economic growth of more than 10 percent will spur corporate earnings. China has 17.2 trillion yuan ($2.25 trillion) of household deposits that have been earning less than the rate of inflation, encouraging savers to shift money into higher-yielding assets.

High Valuations

"Right now, valuations are relatively high, but if you look at liquidity, at the amount of domestic savings, that liquidity's got to go somewhere," said Sean Tseng, who manages about $50 million at Polaris Securities Co. in Hong Kong.

The central bank on May 18 raised the deposit rate to 3.06 percent from 2.79 percent to help cool investment. The government also this month allowed China's banks to buy stocks overseas for the first time, easing a ban that's contributed to the high valuations by limiting investment options.

Stock investing has so gripped the public that it has caused labor shortages, according to local media reports.

About 10 percent of maids in Shanghai have resigned because they make more money trading shares, the government-run Eastday Web site reported on April 24, citing a local employment agency.

A Shanghai training company has set aside half an hour twice a day for employees to play the market, the Oriental Morning Post reported on May 17, without identifying the company.

Maids, Monks

Shi Changxing, a 60-year-old monk, trades stocks from a computer in his room in a temple in Xi'an in northwest China, state-controlled broadcaster China Central Television reported on May 10, citing a local newspaper.

Shanghai investor Wang said he's made a threefold return on the 100,000 yuan he invested in the market in August. His profit is equal to 40 times his former monthly salary of 5,000 yuan.

Wang's picks include Hebei Weiyuan Bio-Chemical Stock Co. and Xugong Science & Technology Co. Weiyuan Bio-Chemical stock gained 281 percent in the past year, while Xugong -- a construction machinery maker in which U.S. buyout firm Carlyle Group bought a minority stake -- has risen 292 percent.

China "is another one of these classic hot and speculative markets that will end in tears," said Hugh Young, who oversees $35 billion as managing director at Aberdeen Asset Management Asia Ltd. in Singapore.

"Chinese Investors Crunching Numbers Are Glad to See 8s" (via the Wall Street Journal):

When a friend whispered several stock tips to Yan Caigen last year, the investor snapped up 30,000 shares in one of them, a cement company. The reason: the stock's auspicious ticker code, 600881, which contains a double-eight.

"I believe good codes will bring good luck," says Mr. Yan, who parks himself most days in front of a trading screen at a Shanghai brokerage, Shenyin & Wanguo Securities Co. Indeed, shares in Jilin Yatai (Group) Co., the cement company he bought, promptly tripled, earning him about $50,000. Mr. Yan gives credit for the performance to the two "8s" in the stock's numeric ticker symbol, which he considers a lucky combination.

Part superstition and part self-fulfilling prophecy, numerology is a basic trading strategy in China. The philosophy reflects the widespread belief in Chinese society that numbers contain clues to good fortune.

It is a little noticed force adding fuel to a roaring market in the world's fourth-biggest economy. The benchmark Shanghai Composite Index is up 56% this year and quadruple its level at mid-2005, a spike that is raising concerns about an investment bubble.

Investors' zeal to base decisions in numerology also helps explain why Beijing has been unable to temper enthusiasm in the stock market through conventional measures, like credit tightening last week.

To professional observers, the Chinese investing public's trust in the predictive power of numbers -- rather than fundamentals like business prospects or profit -- is one of many reminders of how buying on the Shanghai and Shenzhen stock exchanges looks like gambling.

Brokerages are set up like casinos. Investors drink tea, smoke and chat as they make trades on computers lined up like slot machines. Instead of dropping in coins, they swipe bank cards to pay for shares.

"You know, we're individual investors. We often choose stocks very blindly," says Shanghai investor Chen Guoan. Some pass cigarettes to congratulate friends at seeing the price of their stock rise.

In China, individuals, often with little understanding of financial concepts, make up 60% to 80% of trading, unlike U.S. markets dominated by financial giants such as Goldman Sachs Group Inc., Merrill Lynch & Co. and Fidelity Investments Inc. "You see strange things happening with stocks, with lucky numbers, codes," says Jing Ulrich, chairman of China equities for J.P. Morgan Chase & Co. "This is a reflection of a very immature market."

Much of China's urban middle class has money in the country's nearly 100 million personal trading accounts. Record numbers of new investors, often with little understanding of market mechanics, are also jumping into stocks, opening more than 100,000 accounts on the average day this year. The government has warned of dangerous levels of speculation as investors fund their purchases with second mortgages and credit cards. In recent weeks, daily trading value has soared to nearly $50 billion.

Each successive record high for stocks -- including three this week -- is giving rise to fears of an investment bubble. Economists worry a burst could sap the spending power of China's nascent consumer class and reverberate through global commodity and stock markets.

Asia's famed "Superman" investor, billionaire Li Ka-shing last week warned, "As a Chinese, I am worried about the stock market." Twice in recent months, a sudden correction in Chinese stocks has rattled markets world-wide.

The absence of a free press in China and regulatory constraints on what financial analysts can say publicly leave investors vulnerable to unusual trading theories. They often make do with folksy trading tips such as those now circulating among investors advising people to wear red clothes, which are representative of a "hot" market, and to eat beef to sustain the "bull" run, while avoiding references to "dad," since the word in Chinese is a homonym for "drop."

For 56-year-old Xu Xiaorong, numeric stock codes are critical. He says he sometimes thinks about his Feb. 1 birthday when weighing investment decisions. "I like the shares that end with the number 1. It's my lucky number," he says.

In Chinese society, the homonyms of numbers hold deep meaning. In particular, the pronunciation of number eight -- ba in both Mandarin and Cantonese -- sounds similar to words for "wealth" or "fortune." Consider the kickoff time for next year's Beijing Olympic Games: 8 p.m. on 8-8-2008.

The appearance of an "8" is considered auspicious, whether it is a digit in the share price or a part of the six-number identity code exchanges assign to each stock. "I don't care about a few dimes up or down, compared with a lucky number," one investor bragged in an Internet chat room after paying 8.08 yuan for a share.

In contrast, investors get nervous when they see the numeral "4" since its pronunciation "si" can mean "death." As proof of its destabilizing force, many point out that Chinese stocks began to wobble in early May when the Shanghai Composite Index traded around the 4,000-level for the first time.

Some numerical customs are steeped in history. For instance, China scales its banking calendar and interest rates to numbers in unique ways. Interest is calculated according to a year with only 360 days, and interest-rate changes are made by margins of 0.18 and 0.27 percentage points, numbers that all can be divided by 9.

Last month, People's Bank of China Gov. Zhou Xiaochuan told a conference the unusual policy reflects how Chinese banks once calculated interest charges with an abacus. The 2,500-year-old mathematical tool can't easily handle decimals that repeat infinitely, as tends to happen in calculations with the 0.25 percentage-point increment used in interest-rate changes almost everywhere else in the world. Even in recent years, Mr. Zhou said, bankers "in the countryside didn't have calculators." Since 1980, every adjustment in benchmark interest rates has been set according to this method.

Today in China, letting numbers guide the way through geomancy, basing architectural decisions on feng shui principles and otherwise employing ancient traditions is standard practice. Bank of China Ltd. puts its trading rooms on the eighth floor of its buildings. China's tallest skyscraper, the Jin Mao Tower, is 88 floors high.

The 6, 8 and 9 keys on ATMs made by Diebold Inc. wear out first because those "are considered lucky numbers in China," according to spokesman Joseph Richardson.

When Shenzhen-listed manufacturer Tianjin Teda Co.'s shares closed at 19.48 yuan in April, Xintai Securities Co. said in a research note that "the stock likes closing at a lucky number."

Shanghai investor Mr. Yan explains that stocks with "8" in their code actually deserve a second look for fundamental reasons. For instance, he figures that a company's managers must have savvy in order to secure a ticker code with the number "8." After Mr. Yan bought shares of the cement maker Jilin Yatai last year, the price surged to more than 18 yuan, from 5.27 yuan.

Numbers don't explain everything, he admits, but "in the stock market, half your results come from luck."

"China's New Day-Traders Look to Back 'Black Horses'" (via the Financial Times):

The thousands of ordinary Chinese who are signing up each day to trade shares are not too concerned about the conventional ways of valuing a stock, but they need to know the difference between a ghost and a black horse.

Chinese have combined a traditional delight in word-play with their new-found passion for stocks to create a rich supply of colloquial jargon for investing that is bandied around brokerage offices.

"Ghost shares" are highly risky, but "black horses" have beaten expectations. Buying cheap to sell high later is known as "fighting for the hat", while selling at a loss to avoid further losses is "meat slicing". Investors who think a piece of news will boost prices claim to be "lifting the sedan chair".

When a fund manager was sacked last week for allegedly manipulating share prices, websites hummed with talk of "rat investors", the term for insider traders.

There is even a Chinese phrase that could define the current boom. On top of bulls and bears there is the "deer market", when large groups of amateur, short-term speculators cause markets to move in erratic jolts.

The jargon is being quickly learned by the long lines of new day-traders who have helped push share prices up 52 per cent this year - on top of last year's 130 per cent rise - but who are making the market look increasingly over-valued.

Despite an interest rate rise on Friday aimed at cooling the market, retail investors ignored the messages from Beijing and opened 287,000 trading accounts on Monday, 35,000 more than on Friday.

The explosion in day-trading has created some unintended consequences in Shanghai in the form of unwashed dinner dishes, badly ironed shirts and dusty floors. In recent weeks the city has developed a shortage of ayis, the domestic helpers who do chores in the homes of middle-class families, because some have found more gainful employment playing the market.

Sheng Min, who runs a Shanghai agency that recruits ayis, says it started to face problems finding new domestic helpers in April because of the stock market fever and now has 50 per cent fewer women on its books than usual.

"We occasionally receive phone calls from employers complaining about their ayis," he says. "Some of them seem to be more interested in chatting about stocks with their friends than working."

Zhang Wei works most weekday mornings in houses around the city, but recently she has been visiting a brokerage in Shanghai's Hongkou district in the afternoons. "Last month I made almost half my salary from investing," she says.

With an eye on the new day-traders, an advertisement was placed on the Taobao auction site last week selling doctors' certificates for one month off work for Rmb100 ($13, €9.70, £6.60). It has since been removed.

Cynics would say speculator-ayis are a sure sign of a bubble, but if everyone continues buying, prices will keep going up - even in a deer market.

I wonder: is "three" a lucky number in China?