CIBC Warns On Chinese Bubble

Although the CIBC Economics Department says “the eventual correction/burst of the Chinese stock market would probably be the most anticipated burst in the history of financial market bubbles,” I still found these figures fascinating. Here is their report from last Friday:

A stock market that rises by 200% in 18 months is not necessarily a bubble. But a stock market is a bubble when:

- The value of shares traded daily in this market is double the value seen in stock markets twice this size

- Its P/E ratio is three times higher than its neighbouring countries

- 80% of fourth-year students are also stock investors

- 75% of the market is “naive money” – held by individuals, and only 25% is held by institutional investors

- 400,000 stock accounts are opened daily

The Shanghai stock market is a stock market without a country. Valuations do not reflect the shape of the economy and have no correlation whatsoever to corporate profitability. It’s a question of when, not if, the Shanghai market will correct. And when it does, not too many people will be surprised. The eventual correction/burst of the Chinese stock market would probably be the most anticipated burst in the history of financial market bubbles.

The more interesting question is what would be the ramifications of such a correction on global equity markets. We already have had two dry runs. The 9% plunge in the Chinese stock market in late February led to a domino effect in most other markets. The S&P 500 fell by more than 3%—its steepest drop since 9/11. The TSX dropped by more than 2.7%, the Nikkei fell by almost one percent and the British FTSE, the German DAX and the French CAC fell by 2.2%, 2.0% and 2.6% respectively. But the second drill on May 30th yielded totally different results. The Shanghai index fell by 6.5%, following the increase in the stamp tax on investment, but the response of global stock markets was a collective yawn, with the S&P 500, in fact, reaching a new high on that day.

Global markets may be more linked than ever before, but investors are growing accustomed to wild swings in Shanghai. At the heart of this rising indifference is the realization that the wall of capital constraints that Beijing maintains on its currency, while contributing to the current surge in valuations, also means that the mainland stock market is an island unto itself, detached in any real sense from other markets.

And despite the recent boom, the stock market is still a relatively small part of the economy, even by the standard of emerging markets. The market cap of China’s stock market represents just over 14% of GDP—one-fifth the size of the Indian stock market and a quarter of the market cap of the Brazilian market. And any negative wealth effect on the consumer due to a correction will be largely offset by the more than US$2 trillion in liquid savings held by Chinese households.

Global equity markets will easily withstand a Chinese stock market correction. But the millions of housewives, students and retirees that are now entering the market will not fare as well.

Comments

[John Gaats:]

I have not read the report. But there are considerable misinformation contained in your quote. I wonder how a reputable firm allows that kind of gossip dressed up as corporate report. The best conclusion I can have is that CIBC trusted someone without real understanding of China to cover that market. I also doubt if there is any relevence to FXI and PGJ.

2007 Jun 11 10:13 AM

[James:]

Even though your opinions may be valid - John it strikes me that you need to be more respectful in your comments,
I have read your replies to lots of posts and even though I agree with what you say most of the time - you can not go about commenting in the way you do.

2007 Jun 18 12:53 AM

[huangthomas:]

Hot money from Hong Kong, Taiwan, and other oversea Chinese....is flooding the Shanghai market. In order to trade in the lucrative A-share market, they are using identities of Chinese citizens to open accounts. These accounts are referred to as "Ren-tao hu" (literally, human-head accounts). It does not mean 4th graders or 100-year-old grand ma are playing the market. To avoid attention, the money is dispersed to as many accounts as is possible. Therefore astronomical number of accounts are opened. Believe me, they are "smart" money. Of course, there are "dumb" money from Chinese retail investors as well, but the share of dumb money is hard to estimate.

2007 Jun 11 11:49 AM

[James:]

Great insight – that’s a fantastic way of evaluating things....it is also very consistent with how Chinese do business. I look at China as a group of Chinese families and the group mentality that is genetically/culturally engrained in the Chinese mind is the secret of understanding how the Chinese invest. I would say that it is very likely that China has more underground/family fund syndicates than the USA has institutional mutual funds.

People cite dumb and smart money when looking at trading activity. I think people should look at whether the money is for investment or speculative purposes. If the majority of the money is speculative then it is very possible that the chinese market will be subject to becoming a bubble and bursting. However the market could be supported if a high percentage of the 2 trillion savings moves in the market with the view for it to stay in the market to be used for retirement etc. Then you get a situation where PE ratios are high and the market is overvalued for a number of years but does not experience a severe full and earnings catch up with valuations.

One thing’s for sure if China becomes the biggest economy in 15 years like some predict. The shanghai stockmarket in 15 years can easily sit at 15 000. I wonder how many people would then look back and say I wish I purchased stock when people were predicting the bubble would burst in 2007 when the market was valued at 4200.

I would also like to bring everyone’s attention to what a real bubble looks like. In my mind the shanghai market as it is, is not a bubble. Take a look at Yunnan Pu-Erh tea prices. Up 20 fold since last year. That’s a bubble – a bubble that will burst. The shanghai stockmarket rising from undervalued to over valued in the last few years is not
By any means a bubble.

Another thing to understand is that a by product of global inflation is earnings inflation. So PE rations of 44 mean absolutly nothing right now until perception/growth of china changes. Which from what I can see isn’t going to change for a least 2/3 years.

The time will come when the market gets hit – but the time is not now…..

2007 Jun 18 01:24 AM

[omodes123:]

thanks for the knowledge, huang.

2007 Jun 13 11:50 PM