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September 08, 2007

China Stock Market Bubble, Bubble Trouble?

posted by MR WAVETHEORY at 9/08/2007 05:43:00 AM
Everyday, China stocks are hitting new highs with regularity that reminds me of the 1999 bubble. It's so simple to make money in Chinese stocks that I have started to wonder how long this can continue to go on.

Back in May, former US Federal Reserve chairman Alan Greenspan warned that the Chinese stock market could undergo a dramatic correction. They did. Then, shortly, they proceeded to go even higher. Shorting the Shanghai index? Big mistake. Result: More people are piling in!

Some would argue that the China Bubble started just yesteryear. Hardly is that the case as yoda would say. It started in 2004 with the IPO of China Green. China Green, what's that? That's what I asked too. Turns out it is a seed and fertilizer company! Don't laugh. As an investor more astute than me observed back in 2004, "Though China Green’s business literally involves small potatoes – cubed and shipped in plastic bags – its initial public offering in Hong Kong was anything but. Retail investors put in bids to buy more than 1,600 times as many shares as were available, making it the most oversubscribed IPO ever in Hong Kong. The stock jumped 58% last Tuesday, its first trading day." IPO price: around 1 HKD. Today's price: 6 HKD. Net profit: 500%. Do you believe me now?

And the bubble can start to pop now that we're heading into an election year. “If there were a prospectus for the Chinese economy, it would need to warn of a high dependence on sales to America. China exported $125 billion worth of goods to the US in the first 10 months of last year and imported just $22 billion. The resulting trade surplus equalled an extraordinary 9% of China’s entire economic output during this period. That has turned Chinese exports into obvious targets during an American election year." Forget the Olympics of 2008. It's election 2008 here we come. Say hello to tariffs and trade wars!

Politics aside. The Chinese stock market trades at an average of 42- times earnings, making the Chinese market the most expensive of the world's major markets. The S&P 500 peaked at 44-times P/E during the Nasdaq dot com bubble. The Nikkei bubble of the late 80s peaked at a P/E of 78. At the height of the frenzy in 1989, PE ratios of Taiwan's listed stocks averaged more than 100 (in contrast to 13 in the United States and 10 in Hong Kong). Taipei Business Bank's shares traded as high as 358 times its annual earnings,

All you need is a massive amount of sell orders as wikipedia describes.

One possible cause for the collapse of the NASDAQ (and all dotcoms) were massive, multi-billion dollar sell orders for major bellwether high tech stocks (Cisco, IBM, Dell, etc.) that happened by chance to be processed simultaneously on the Monday morning following the March 10 weekend. This selling resulted in the NASDAQ opening roughly four percentage points lower on Monday March 13 from 5038 to 4,879-the greatest percentage 'pre-market' selloff for the entire year.

And that was the beginning of the end.

Morgan Stanley says the end is near, calling recent growth in Chinese share prices “inflated,” yielding a stratospheric aggregate price-to-earnings ratio estimated at 58, using operating earnings as the proper yardstick for valuing China's popular A-shares, a stock class reserved for domestic investors. Apparently, much of the earnings growth is due to non operating items like ... you guessed ... investment gains.

Even the Shenzhen stock exchange came clean in their mid year report on company earnings. According to the report, the interim profit figures relied too much on yield of investment in the securities market and the prospects of a continued profit increase is doubtful. The contribution ratio of business revenue to profit fell 27 percent year-on-year while that of investment yields to profit soared 50 percent, said the report. Yes, the car guy is spending more time trading stocks than building cars. Big mistake.

If that's not enough, China's premier Wen Jiabao, “I want to tell you frankly that China is still a developing country with a large population, a weak economic foundation and underdeveloped productivity. This is a reality that has basically remained unchanged,” he said. Dude, you're the premier. I thought you were supposed to be the cheerleader.

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