The Chinese stock market is “looking precarious.” That was the warning from Citibank’s technical analysis team at the end of February.
At that point in time, the main indicator of the well-being of the Chinese stock market, the Shanghai Composite Index, had just regained the 3,300 level that it had attained several times during January, only to fall back briefly to below 3,100 in early February.
However, what concerned the Citi analysts was not the relatively small moves in January-February, but the rather more dramatic and impressive surge in the Chinese stock market that had started in mid-2014. In May, June and July, the Shanghai Composite had touched the 2,000 level and was threatening to fall even further than it had in late 2012 and 2013.
But that threat proved baseless: Instead of falling, the index took off on a phenomenal run. In August it crossed 2,200, in October it reached 2,400 and in November it seemed to be stabilizing around the 2,500 level – a logical and desirable move after a rapid 25-percent rise.
But that was not the way things worked out. In early December, the Chinese equity market blasted off in a renewed surge that was far more powerful than the earlier one. By mid-January, the Shanghai Composite was at 3,400, having soared some 36% in six weeks or so.
The subsequent volatility in January and February was, presumably, the proximate cause of the Citibank assessment that the market was “looking precarious.”
Yet by the end of March, the index was at the 3,800 level, having added another 15% in March alone. If Citibank was right in describing 3,300 as a “precarious” level, then 3,800 is simply hair-raising. Mind you, the Shanghai Composite is the more solid, “blue-chip” kind of Chinese equity index.
The Shenzhen Composite Index, representing the companies traded on the Shenzhen exchange, is a much more speculative vehicle.
That index jumped through the 2,000 level on April 1 after bottoming around the 1,000 level last summer. At first sight, the 100% rise in the Shenzhen index is not very different from the 90% jump in the Shanghai index over the same period. In fact, though, Shenzhen was a laggard until very recently.
In late January its index was at 1,500 – but it closed the gap via a 33% leap in March.
While it is true that equity markets around the world have been generally doing well, no other important market has come close to emulating the Chinese rampage.
What gives? And is it indeed precarious or worse – or can there be further sharp rises still to come? Obviously, no one can dismiss the second possibility, especially after what happened in March. But the latest shenanigans merely serve to highlight the fact that the Chinese markets are in a mania stage, which is inevitably followed by a crash. That outcome is certain, only the timing and the level from which it takes places remain unknown.
The cause of this mania, according to many analysts, is that the Chinese economy is slowing and many corporations are losing money, if not in danger of actually going bust. If this sounds strange, that can only be because you still subscribe to the quaint notion that equity markets and the prices of securities registered on them are related to the current and future well-being of the companies whose shares are traded.
In reality, today’s markets move on the basis of liquidity flows into and out of them, and the momentum generated by the liquidity- based buying and selling that takes place in the markets. In the specific case of China, the government has deliberately reduced the flow of state-sponsored lending to industrial firms and of mortgage finance to banks and households. Economic growth is slowing to levels not seen in China this century, with the property market in particular sinking.
To make matters worse, the Xi Jinping-led government is cracking down fiercely on corruption.
That has forced rich Chinese businessmen and their government and army lackeys to lower their profile – expensive gifts are out, as is gambling in Macau. There is, therefore, an enormous amount of loose money sloshing around that can no longer be “invested” in real estate or consumed conspicuously.
Thus deprived of its usual channels of activity, this money has flowed to the bourse.
The process has been the same as anywhere else, but on a Chinese scale. Thus, after the flows of “smart money” from the wealthy and well-connected class, has come the “dumb money” of the masses.
As early as last September, China analysts began noting a sharp rise in the number of new brokerage accounts being opened.
These accounts have been using credit to amplify their exposure to the market, so that a growing percentage of the trading is being financed by borrowed money – which makes it far more profitable so long as prices are rising, but also far more vulnerable to a downturn.
However, this trend has massively swollen and the latest revelations about who is getting into the game – from Bloomberg, earlier this week – are simply stunning.
In a nutshell, Bloomberg unearthed Chinese data that show that the new cohort of “investors” are primarily people with little or no education.
Of the new investors, 5.8% are “not literate,” 25.1% have elementary education only and 26.7% made it to through junior high school. That’s two-thirds of the newbies who have little or no education – compared to about one-quarter of the “old” or existing investor accounts.
Semiliterate people are driving up the market, using borrowed money. That certainly qualifies as “looking precarious.”