The Shanghai Composite Index is now down almost one-fifth from the highs it reached last month, prompting talk of it entering a bear market. Markets across Asia and, indeed, in Europe, have tumbled in sympathy.
Why are stocks in China falling? A simple explanation is that even after Wednesday’s fall, the Shanghai Composite is up 50% this year. Earlier this month, independent economist and former Morgan Stanley analyst Andy Xie had warned that the Chinese market had become “a giant Ponzi scheme”.
“The stock market is in a final frenzy again. The most ignorant retail investors are being sucked in by the rising momentum. They again dream of getting rich overnight. As in the past, retail investors usually lose, especially like the ones jumping in now. The final frenzy usually doesn’t last,” he wrote. But Xie said he expected the correction to occur in the fourth quarter.
The timing of the pullback has to do with the fall in liquidity in the Chinese market, as the volume of bank loans in July fell 77% from the June level. A large proportion were short-term bills that were discounted, whose proceeds found their way to the stock market.
Graphics: Ahmed Raza Khan / Mint
Citigroup Inc. analyst Lan Xue says in a recent research note: “As we entered July, the retirement of such bills also placed a negative burden on the market liquidity.” The chart shows the shares of bills discounted and new lending other than bills month-by-month. Another signal of retail interest in China’s markets waning is the slower pace of new broking accounts being opened.
But is it just the Chinese market that is a concern or is the economy also at risk? That’s the worry for other markets, as Chinese growth was one of the few bright spots in a weak global recovery. If this boom is bogus, that will have a fundamental impact on global sentiment and on commodity prices.
Well, here are the latest numbers for the month of July: industrial production—up 10.8% year-on-year; retail sales—up 15.3% y-o-y; fixed asset investment—up 32.9% y-o-y. Analysts were disappointed with these numbers but, as you can see, many economies would be proud to be able to show this kind of growth. But then, there’s also plenty of scepticism about Chinese growth numbers. But that’s not all. There has been a spate of upward revisions to Chinese GDP growth in the last two months, Goldman Sachs being the latest. The brokerage now forecasts a 9.4% growth in China’s GDP this year and 11.9% next year. That’s far more bullish than the Chinese government’s own estimate of 8% growth in 2009. Here’s what a Citigroup note of 17 August says: “The moderation in the pace of growth in July was a welcome change. But both investment and credit growth remain sufficient to power the recovery. Now, with trade potentially on the mend and unemployment pressures easing, the odds are rising that near-term growth could far exceed official targets.”
Citigroup analyst Ken Peng points out that inflation remains subdued, liquidity sufficient for growth; he doesn’t expect monetary tightening till the first half of 2010.
The crucial question is: is China’s growth running out of steam? So far, few indicators point to that. As Peng puts it, “Risks remain abundant, such as asset bubbles, rising debt and overcapacity. But vast state resources help to mitigate these risks and buy time to promote a consumer economy.”
That should be cause for comfort for other markets.
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