Why Went Wrong with The Super Hot China Stock market?

In 2007, we saw the Shanghai Stock Index went from 2,700 points to 6,100 points. A staggering 126% gain. The China economy was going very strong, hot money was rushing into the country from global investment funds. Property market was also gathering heat and the locals were taking a free ride on the fast appreciation of RMB currency against the USD. (From 8.28 before de-pegging to the current 7.09 against $1)

Year 2008, the Beijing Olympics year for China has been viewed as a very sunny year. I remember at the end of last year and even beginning of this year, 95% of Asian stock analysts supported the view that China stocks are going to shoot through the roof from Q1 to Q3, surfing the Olympics wave and the RMB appreciation tide, and would only cools off in Q4 of 2008 for a needed technical correction. But since the start of 2008 the Shanghai Index has dramatically swooned to the unbelievable 3,516 level today - the March 20^th, 2008. This is a nearly 45% drop from its highest peak. What went wrong? What are still looming ahead of China stock market? Is the bull still around?

I think 3 key factors have caused the present market agony. Firstly is the over-valuation of China stocks in the A markets traded in the Shanghai and Shenzhen exchanges, which are only open to the local investors. The locals who were optimistic in the Chinese economy, in the last few years, perceived PE ratio of 30 times as a very normal level to buy in and leverage on China's economic future. Only those companies which posted 100 or more are thought to be overbought. Look at the Hong Kong Market and other developed nations’ stock markets: anything beyond 20 times of PE are positioned for selling pressure by investors. When Warren Buffett sold China Petroleum at HK15 a share last year, the local investors in China were still rushing and daring to buy the China Petroleum A stocks at RMB38. The over optimism of the China economic future, the only perceived strong future performances of local companies pays a heavy penalty, as local investors realize now they have to see past returns as the solid ‘rock’ references and not to use the future promises as their ‘sandy’ foundation.

The second cause for the quick erosion of China market is the overlooking of the great 'unloading' impact of local restructured companies who are allowed to sell their holding of shares after 6 months or 12 months of their share floating or restructuring. Many restructured entities got past the ‘Closed Window’ periods and are given green light to sell their holdings to the open markets. Although the market index has gone to the pit bottom - an oversold position, but to many of these holding entities, their historical reference prices of their portfolio could be just 10% to 20% of the current share prices. They are still gaining multiple 100% even they sell off in the current bearish market pit.

The sub-prime effect of the U.S. is the 3^rd factor in pushing the China stocks down. In the past few years, many investors thought China as the single strongest developing economy with 1.3 billion population market and would be self-sustainable, without being affected by the outside economies. But USA continues to be the major importer of China products. In these past 3 quarters of US sufferings from its sub-prime crisis, this western leading economy is on the edge of a fearful recession. This definitely threatens its huge reduction in imports from China. In fact many Chinese factories are feeling the direct reduction exports impact. In tandem with the RMB currency appreciation, the import prices of merchandises increase, posing a gloomy future for Chinese factories. Listed companies which rely mainly on exports are greatly affected in future revenues.

We live in a connected borderless world. Company value perception, risk prevention and the problem of one nation such as the sub-prime crisis have all become global and international. Such is the new breakthrough realization of the Chinese stock investors.

Published by http://www.101stockinvestments.com

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