China's Bull Market: Massive Underlying Risk Still Exists

| About: iShares China (FXI)

The best bull argument I can find in regards to the Chinese market is that the government has little choice but to keep liquidity flowing, even if they know this will be negative in the long-term.

Since a government "investigation" can't possibly yield much, and since they're saying flat-out that lending won't be capped, this sounds incredibly bullish. China isn't going to take away the punchbown -- as we've noted, they just can't. When even the slightest hint of lending curbs recently brought up, the market tanked nearly 7%. Imagine if the threats were real. The bubble must roll on.

The government may fear the potential repercussions of deflating asset prices in the short term so much that they are willing to ignore the longer term consequences of fueling asset prices further. Fair enough, sounds like standard human nature when it comes to politics and just today Chinese officials have said they will investigate price gains but won't cap new lending. Thus if you openly regard this as a punt on the government's actions, fair enough we can't argue that. But...

We can warn that there is massive risk in such a punt and little edge one can bring to the table unless you have your own fly on the wall in Beijing. Where we take issue is if you say that this market is supported by fundamental value at current levels, or that buying is an "investment". Even the bullish Goldman (NYSE:GS) strategy piece we confronted said valuations were high, but just hoped for more liquidity to keep coming (greater fool theory). An old China hand sees valuations stretched as well. The problem we see with the bull case is that it's underlying support could turn on a dime based on government whim and collapse in an instant.

All Chinese market bulls at these levels are punters, whether they know it or not. And we hope it works out for them.

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