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Shanghai Composite Index - best performing in the world

Shanghai’s key stock index is enduring unprecedented volatility after registering its biggest weekly loss since February. Today, the Shanghai Index rebounded and ended above 2,900 points after yesterday’s slide. On Monday China’s main stock index tumbled another 5.8%, leaving it down 16% for the month. At the end of last week, Shanghai tumbled three percent, or 93.59 points, to 3,046.97 at the end of the last trading week.

The Shanghai Composite Index has now dropped to its lowest close in six weeks. The volatility in Shanghai is unrelated to foreign markets because shares cannot be traded (arbitraged) across exchanges. Shanghai is a liquidity-driven casino at this point, but it is dragging down dome of our ADRs.

As you may remember, many China investors have been flocking to mutual funds which invest in the Shanghai market. The reasons were obvious enough. The Shanghai Index was the best-performing in the world, with gains that peaked above 90% for the year.

We cautioned against buying in several weeks ago, warning subscribers of a possible bubble developing on the Shanghai Stock Exchange. As we said, the valuations of corporations traded in Shanghai, Hong Kong and New York were out of line. Valuations were dramatically higher in Shanghai than in other centers for specific companies and for comparable companies.

Another warning sign of investor frenzy is the number of new retail investor trading accounts being opened. Investors opened almost than two-and-a-half million new accounts to trade stocks in the four weeks before August 7th. That’s the greatest investor stampede since the Shanghai bubble of December, 2007.

Various business news outlets are now speculating about whether the downturn in Shanghai is a brief “correction” or the beginning of a protracted downturn. Many Chinese analysts are saying that Shanghai is merely in correction mode and will resume its rise in the near future.

That’s not a safe bet. There are number of reasons to worry about continuing declines or stagnation.  The pending launch of a NASDAQ-like Growth-Enterprise Market may divert capital out of the main exchange. The unlocking of new IPOs which initially caused a rush of excitement may also dilute available capital. In addition, millions of so-called untradeable shares are due for release, creating further strains on liquidity.

Adding to the pressure on shares in China is the worry that a lot of market speculation has been fueled by high-volume bank lending brought about by a government decree. Although Premier Wen Jiabao has pledged to continue China’s “relatively loose” monetary policy, the volume of new bank loans may be declining. The deputy head of the country’s statistics bureau says China must be careful to keep its economy from overheating because that could fuel a spike in inflation, adding to pressure in Beijing to tighten monetary policy.

With Shanghai shares still trading above international valuations, there is room for further market declines. The Shanghai Index is below its 50-day moving average with little apparent momentum to change direction.

A-shares, traded in Shanghai, cannot be purchased by foreigners but several mutual funds do give access to the Shanghai Composite Index. It appears that buying these funds now would be, at best, buying into a bubble – at worst buying into a bursting bubble.

What Shanghai’s Sell-Off Frenzy Means for the U.S. INVESTORS

Analysis and Commentary from Leading China Expert Jim Trippon, editor of the China Stock Digest.

FACT: Shanghai’s key stock index registered its biggest weekly loss since February, last week. Today’s China’s main index tumbled another 5.8%, leaving it down 16% for the month, its lowest close in six weeks.

FACT: Many US investors have been flocking to mutual funds which invest in the Shanghai market. The reasons are obvious. The Shanghai Index was the best-performing in the world, with gains that peaked above 90% for the year.

Q. What are the possible reasons for the sudden drop in Shanghai’s Market Index?
A. “We cautioned our subscribers weeks ago of a possible bubble developing on the Shanghai Stock Exchange. As we said, the valuations of corporations traded in Shanghai, Hong Kong and New York were out of line. Valuations were dramatically higher in Shanghai than in other centers for specific companies and for comparable companies.”

Q. Does this mean we are in a minor correction or the start of another bear market for China equities?
A. “Many Chinese analysts are saying that Shanghai is merely in correction mode and will resume its rise in the near future. That’s not a safe bet. There are number of reasons to worry about continuing declines or stagnation.  The pending launch of a NASDAQ-like Growth-Enterprise Market may divert capital out of the main exchange. The unlocking of new IPO’s which initially caused a rush of excitement may also dilute available capital. “

Q. Has China’s bank lending policies fuelled a bubble in the Shanghai market?
A. “It certainly looks like this is the case. China’s banks lent $1.1 trillion in the first half of 2009, some of which ended up in speculative stock positions of the borrowers. It remains to be seen how China will refocus their stimulus efforts in the second part of this year. The deputy head of the country’s statistics bureau says China must be careful to keep its economy from overheating because that could fuel a spike in inflation, adding to pressure in Beijing to tighten monetary policy.

Q. What other signs of worry are there?
A. “Another warning sign of investor frenzy is the number of new retail investor trading accounts being opened. Investors opened almost than two-and-a-half million new accounts to trade stocks in the four weeks before August 7th. That’s the greatest investor stampede since the Shanghai bubble of December, 2007.”

Jim Trippon
Editor
China Stock Digest

www.chinastockdigest.com