It’s official: There is nothing like a good old Communist Party powwow if you want to get the stock markets excited. Heaven knows what would happen if the openings of the party congress, 2008 Olympic Games and 2010 World Expo were all pushed to the same day. For one thing, we’re guessing taxis might be hard to come by.
As it was, the sight of several hundred men in dark suits, white shirts and red ties – female and creatively-dressed ethnic minority cadres excepted – was sufficient to send the Shanghai Composite Index (SCI) through 6,000 points.
It hovered around 5,700 over the course of the next week before posting a 2.59% decline on the day the new politburo standing committee was unveiled. Is there something about the potential fifth generation leaders that should concern us? Or is the current generation perparing to indulge in a spot of belt tightening now that the festivities are over?
In the dog house
If the Red Dragon Fund was in politics, we fear our public opinion polls would make for pretty gruesome reading right now: The fund has underperformed the market for the past two months. However, like all politicians, we have an excuse. It is the “20-80” phenomenon, whereby the 20% index-weighted stocks rally while most of the others drop.
Can we be blamed for buying into a second-tier company with high growth potential – Jiangxi Ganyue Expressway 600269 comes to mind – instead of the blue chips that underpin the index?
The kneejerk answer to that is yes. But look a little closer and you see a market that still appears to fly in the face of reason. The average P/E ratio of A-share stocks in September was close to 60 and the turnover rate 793%. The turnover in the US and Hong is less than 100% while in Taiwan it is 127%.
This suggests that traders are being driven by short-term speculation rather than long-term investment. It is the institutional investors rushing in for quick gains on the blue chips that has created a bubble around these stocks.
No matter what the regulator does, the liquidity giving momentum to this upward spiral will not be drawn out. Each time the central bank has raised the interest rates, the index has rallied. The fact that China Shenhua Energy 601088 attracted an astonishing US$355 billion in subscriptions for its listing in October is evidence that there is far more cash than monetary policy can control.
Well known economist Larry Lang has a slightly different take on the situation. He argues that very failure of the tightening measures suggests that the stock market bubble is not caused by excess liquidity at all.
According to Lang, the deteriorating business environment in China means money has been pumped into the stock market rather than the real industrial sectors. These funds compromise the biggest share of the capital that drive the equity market. Second and third places are occupied by officials investing the fruits of their corruption and global hot money respectively. Deposit liquidity is barely on the radar, he argues.
If we are correct in our thinking then the post-party congress slip in the SCI is just a harbinger of what is to come. Less distracted by politics, the government is ready to tackle bubbles in the stocks and housing markets. The fourth quarter may not be an easy one for investors.
In August 2005, CHINA ECONOMIC REVIEW decided to invest RMB10,000 in A-shares. And so the Red Dragon Fund was born…