Shanghai Should Continue to Sell Off

U.S. investors are getting inured to the bad news about American financials and insurers. Gold bugs are uneasy as gold posts losses of nearly 30% over its highs. Oil investors wonder how their "$300 oil" could have possibly lost $45 per barrel in eight weeks.

And yet, few people outside of TFN are pointing out that the supposed engine of all global growth, China, has dropped lower and faster than any other losing asset except for Fannie Mae (FNM) and Freddie Mac (FRE) stock. (Alright, throw in Lehman Brothers (LEH).)

Only more slowly.

Trading as low as 2,070.427 (a new post-boom low!), the Shanghai Stock Index today closed at 2,078.981. Based on its high of 6,124.04, today's low represents a spectacular loss of 66.05% -- two thirds of its October 2007 valuation.

Last month, I was a guest at TFN's latest Smart Trading video on China. Laura Cadden had invited me to check what I foresee for China. (Take a moment to revisit this interview.)

To make it short and painful: I see financial catastrophe brewing in China. And that is bad news for U.S. consumer prices... and for commodities.

Remember, China's growth and the increasing prosperity of the urban Chinese are considered the prime movers for commodities and especially gold consumption. What is most distressing at this point is that the decline in Shanghai not simply represents a loss in market valuation — but a very real destruction of Chinese middle class savings -- which, as you will remember, were pumped from more traditional savings accounts into trading accounts by the billions last year.

The lower valuations also will work their way into Chinese bank balance sheets: Plenty of corporate portfolio punting was undertaken using indiscriminate loans issued by Chinese banks to party functionaries working in corporate executive positions. If you think paying back upside down mortgages reflecting 10-20% in valuations were dynamite for U.S. mortgage lenders, just wait until last years punting loans come due in Beijing…

You may think that the downside to Chinese stocks now is contained. Don't count on it: There are rumblings in the big four Chinese banks that not just their real estate loans, but their legacy load of non-performing loans are about to hit the headlines before the year is over. When that happens, people will die -- quite literally. I believe there is a corruption purge imminent that will result in at least a dozen top financial official being executed.

And the Shanghai stock exchange may plunge another 1,000 points.

Disclosure: None

Comments

[H-Bomb:]

" I believe there is a corruption purge imminent that will result in at least a dozen top financial official being executed."

Typical SA reader response: "That should happen over here"

Had to throw it out before anyone else.

2008 Sep 12 07:17 AM

[glassbox:]

China's biggest problem is misallocation of resources by a badly developed capital allocation system. Its going to be quite difficult to fix this one...

2008 Sep 12 07:51 AM

[Schweizer:]

A lot of denial on Wall Street, at least that's the public face. In the back rooms, it's all about liquidation and telling retail investors to buy-buy-buy as the bottom is in! (or more like bye-bye-bye to your savings John Q. Public.) Sad and sick game, with CNBC as the mouthpeice of the deception.

2008 Sep 12 08:03 AM

[This Game i...:]

Won't the $1TrillionUSD in their reserves help to alleviate any need for capital by the state banks??

2008 Sep 12 08:03 AM

[fxinot:]

Won't happen. The communist government would fall. Executions, along with a massive absorption of bad loans by the government and a cover up may occur. But the current crop of communists know they can't go back to Mao way of doing business.

2008 Sep 12 09:23 AM

[User 142738:]

Selling $1T in reserves would require the PBoC to print 6.84 trillion yuan. I believe far more than 6.84 trillion yuan were lost in this correction.

2008 Sep 12 10:09 AM

[rlirph:]

With a US$1.8 trillion foreign reserves the country can afford to pay for their mistakes along the way.

2008 Sep 12 10:51 AM

[andyn:]

Money talks... and the fact that the Shanghai exchange is off so much means somethings up. (and remember this is locals pulling money out as foreigners are not allowed on that exchange). So be ready for some jaw dropping revelations, though i think it would be leaked out rather than coming from the Chinese govt who cook all those GDP numbers. Best way to "profit" from this is to be short chinese ETFs

2008 Sep 12 11:39 AM

[canb888:]

Let me be a bit extreme to make my point:
1. How many Chinese companies with more than 500 employees are listed in China? My guess: no more than 2%. If anyone has a better guess or study, please post.
2. If the Shanghai stock market drops to zero, what would be the impact on people's livelihood, the economy and the government? My guess again, not much since the stock market, as many people pointed out, does not act as a major wealth/resource allocator yet. It is more like a casino and people go to Las Vegas to lose money without much impact on the US economy.
My conclusion: the Chinese stock market does not have the same impact on the Chinese economy as the NYSE has on the US economy. There is no reason to link the index directly to the performance of the real economy. Therefore, there is no need to worry too much about the index itself. Besides, the index is not a very good indicator of the economy at all due to the make up of its components which I do not want to elaborate here due to space/time limit. GLTA.

2008 Sep 12 11:46 AM

[canb888:]

Addendum: I do agree with the article that the banking system is a huge liability in China and I have had this view for a long time now. However, the main engine of growth is not the stock market but the real economy which has many problems but, IMHO, is not as bad as the stock index would seem to indicate as explained in my previous comment. GLTA again.

2008 Sep 12 11:52 AM

[Urbane Gori...:]

I had read that there was a 'gambler's fever' investment thinking on the part of the populace in China ... And like our own pumping up of the stock market here due to the increase in money flow from IRAs, it does make sense that China has had a similar lift. What I didn't know was the Chinese were pulling their money back out.. Could be ugly..

jegan

2008 Sep 12 07:27 PM

[James Lewis:]

OH MY GOD!!!

Shanghai stockmarket to 1000!

Come on, this is not a true reflection of the reality of where things are going. We all know that there are a multitude of problems in almost every aspect of the Chinese Economy, Chinese Legal structure, Human Rights and the Chinese Business culture.

But the fact reamins China is the creditor of the West.
Has more than 2 Trillion USD of reserves.
Has enough money, enough political will and enough power to bail out the entire system at least once. Also they know exactly how to do it, having effectively helped the US government in bailing out its financial companies by writitng a blank loan cheque to save its investments.

Property is not as weak as everyone says it is.
The stockmarket is falling because it was bubble overvalued in the first place because of the pyrmaid selling scheme set up by the corporates/local and central govt. And set a light by typical gambling psychology of the Chinese.

The insurance companies are arbitraging dual listed Hong Kong and Shanghai listed stocks. As soon as Share Values are the same over both exchanges, then the selling will stop. Currently there are still a lot of stock that are 30-50% more expensive to buy in Shanghai exchange than the Hong Kong exchange. Once this is removed and the big 2005/2006 IPO stocks (Ping an etc) is priced the same in Shanghai as Hong Kong, we will see normalisation of market.

Shanghai stocks are not cheap, they are certainly not expensive and they have not hit their lows yet. But they are not going to 1000, maybe 1800.

Property is still very cheap compared to International standards.
Shanghai property is 350-400% cheaper (like for like) than Hong Kong, Tokyo and Singapore property.
Shanghai property is 300% cheaper than Mumbai property.
Shanghai property is 450-475% cheaper than London/Moscow/New York property.

So unless the entire worlds property market gets hit very hard (I am not saying this wont happen), then Shanghai property will at the very least stabilise where it is. Infact if the worlds property market crashed I would still rather own Shanghai property than other countires.

Please also note that currently only new property is getting hit in Shanghai, second hand property in central location has not moved. There is no new properties coming on the market in Shanghai in downtown locations. The new proprty that is getting hit was drastically over priced, in second rate locations and was bound to correct.

Short and medium term 'doomsday' predictions are not warranted.
I see another 3-4 years of prosperity.
Long Term we could see a phase of political fallout and a whole host of problems that China has experienced many times in the past, but as yet we are not there.

Hu and Wen I am sure will keep things smooth until they leave in 2012. After that then it is a totally different ball game.

2008 Sep 13 03:06 AM

[User 257960:]

I like James Conrad to comment on this. As many making bold statements with no backup, I will need more study to conclude if this is a spin or honest opinion.

2008 Sep 13 03:52 AM

[buystocks:]

So, when is the time for the investors to jump in? I also agree with what James said, 1800 should be fair, however, It has a chance to go back to 1500 point;

2008 Sep 13 03:41 PM

[rlirph:]

To those who can access Chinese newspaper the decline in Shanghai stock market is not surprising. You just have to understand a little bit about how the market comes about.

Maany years ago all companies are government owned (state owned enterprises, SOE). After all it is a communist country. A company will have shares, owned by different government agencies. The shares were not tradeable.

In 1979 the government started to reform the economy to a more market approach economy. Some companies were allowed to convert some of their shares to be freely tradeable, while a bulk of them were
still not freely tradeable.

Four years ago the government instituted a number of measures to make all the shares tradeable. They set a time table to make all shares tradeable in three years. This is similar to the lock up periods of the IPOs. Unfortunately the amount of restricted shares is more than the entire market capitalization of both the Shanghai and Shenzhen market.
At this rate it will be 2010 before all the restricted shares become fully tradeable.

2008 Sep 14 03:08 AM

[Franck:]

As some readers noted, Chinese stock market does not reflect Chinese economy. In 2001, the Shanghai index topped at about 2240 points and went down to about 1000 point in 2005 while Chinese economy had a high GDP growth.

At that time, many journalist were saying that China is the only country where the economy goes and the stock market goes down.


I think you need more than stock market to evaluate the health of China economy.

I would say that the relative slowdown of the China economy is partly due to the catastrophe of the banking sector in the U.S.

2008 Sep 14 07:49 AM