Just How Big is the China Bubble?

In one of our ETF country and sector rotation screens the screen keeps flashing "buy China" and it has been telling us this for a long time now. I can no longer find the stomach to buy into China ETFs and closed-end funds simply because the market has gone vertical and I've been through that pain before. Furthermore many of our clients remember it all too well also.

I really wanted to see just how big the bubble is so I did an overlay comparison of the NASDAQ Composite monthly closing prices for the 3 years leading up to the spring 2000 crash versus the monthly data for the last 3 years of the iShares FTSE/Xinhua China 25 Index (FXI). I chose the FXI basically because it's widely followed, easily understood, and has now been trading for 3 years.

The resulting linear comparison of the two indices is rather striking and the ascent of the FXI share price is on a nearly identical trajectory to the NASDAQ composite of early 2000. Will the Chinese stock market suffer the same fate as the NASDAQ? I cannot tell but it is clear to me that it will pullback sooner than later and we will all likely feel it no matter which markets we are invested in.

Full disclosure: many of our client account are long in the Nasdaq 100. None our our client accounts hold FXI.

Comments

[ehp246]

Not again.

[Big Mouse]

Bubble has been talked for a long time.

It will come true when no one dare to mention.

[HeadlineWhore]

2nd grade math if you just overlay and expect past performance to predict future results. Nobody will deny China is a bubble waiting to pop sooner or later. Smart $$ will keep growing exponentially until then.

[TraderMark]

What I am curious to see is everyone says "its safe to buy China until the Olympics" Well the Olympics are next summer. And the market is a forward looking mechanism. So if it discounts ahead 3-6 months to next summer.... well that would overlay pretty well on your chart.

While on 1 hand I don't see comparing to completely different bubbles one on top of the other as more than eye candy, it would be sort of amazing if they followed each other paths. I have seen other similarities with housing stocks vs NASDAQ and Japan vs NASDAQ.

[pandaexpresswagon]

The economists this issue has an article re china market prospect (see www.economist.com/fina...). Everything sound rosy so far. what is everyone's opinion. Based on the article, the underlying characteristics of current Chinese economy seems to be very different from that of the US during the tech bubble, ie "tradable shares...is only 35% of GDP compared with 180% in America...in 2000" and huge foregin reserves. I want to be on the bandwagon...

[WebWatcher]

This is not the first time this comparison was made. Not only on other sites, but also once on this site as well.

There is indeed a valuation issue with Chinese stocks. But this type of comparison is simply non sense, stupid.

This is a site read by people with sufficient if not sophisticated math and financial background. Please do not post this kind of kid stuff again. Thanks.

[Jim888]

Not trying to hide my head in the sand - but these charts have nothing to do with each other. Why not overlay the 1920-1933 market on the FXI - has as much meaning as the above? Focus on reality (growth numbers - ForeX rates - China's new investment group CIC - etc...) - not the speculation.

[glendokid]

1. Nice that you didn't monkey with the vertical scale.
2. Because of technological change, the time period 2004-2007 is not comparable to the time period 1997-2000. If you wish, the FXI is actually growing much slower than the Nasdaq did. Things happen faster now.
3. If you want to see if the FXI is in a bubble, you have to use log log vertical scales, not linear. See next comment.
4. For a real test of whether a market is in a bubble, see the book:
"Why Stock Markets Crash", Didier Sornette, Princeton University Press, 2003

A nice review of the book is here:

www.ess.ucla.edu/facul...

5. It seems obvious that the quants at large financial institutions are using all of these techniques.

[blackbox]

How does one get short the Chinese market?

[praha1]

Nasdaq to a very large degree was based on a lot of snuff. Back in 1999 and 2000 many Nasdaq companies were not earning profits but in fact were showing whopping losses. This is not the case with the current Chinese mainland market stocks. Revenues and profits are rising ever faster. There is at least 'some' reality behind the valuations. They're high and they're scary but profits are very real indeed.

China has two approaching failings however:

One they are now by definition losing billions due to a non-floating currency. If possible, the Americans will see to it that they lose billions more.

Second, there is little if any indication that political reformation has kept up with economic reformation.

The above two will eventually be disastrous for China. When is anyone's guess.