Tuesday, July 7, 2015

The real action is where?

So while the world has been focusing on Greece, a small country that accounts for less than 1% of Europe GDP (Yes I know they are people too), the real "global" risk issue is taking place the other side of the world (rather literally!).  The Chinese markets have been having a terrible time, you see over the past 12 months the the CSI 300 [China's equivalent to the FTSE100] has been on a tear -- its up more than 100%, the index has doubled.  Just so that we are clear, profitability has not changed, what has changed is the p/e -- its gone from an expensive 15x to a eye watering 31x.  That's more expensive than anything in the world.  This is a prime example of irrational exuberance (and just a bit of greed too).  What China's investment public has realised is that what's important is not what the intrinsic value of a company is a generator of wealth, but rather what other shmuck is ready to pay for it.  The Chinese stock market became the equivalent of a "fine art auction"; the underlying assets is almost irrelevant it's what the other guy is ready to pay for the trinket that counts!

Now, as long as the road was going uphill (at any rates prices were going up) China's government was happy(ish) but now that the ride is going the other way -- in a rather spectacular fashion, they Chinese government is paying close attention.

Over the past few days they've taken the following action:

  1. Stopped all IPO -- to reduce supplies 
  2. Central banks bailed out stock trading companies
  3. Government banned pensions from selling stock
  4. Rumours that government is using central bank as buyer of last resort
  5. Suspend trading in many many stocks (160 so far) 
Despite these efforts, the stock market continues to fall (despite an 8% upward bump Monday) we are back in the downward spiral.  The investors are being rational, they don't want to be left holding the bag.

The fundamentals never supported such prices, already there are strong assumptions that most Chinese companies "cook the books" which is something we North Americans are well acquainted with (this is not a Chinese sickness -- we all do it), and so what's the value of a Chinese company (based on its stated revenues and assets) is a big guessing game.

However, at issue here are not the companies themselves rather investors (with severe limitations in what they can invest their cash in) all going to the same well -- the capital markets!  The Chinese government tried to deflate the housing bubble -- with some success (at least the pace of growth has slowed), The Chinese government has also cracked down on "near banks" -- second tier lenders that have kept small private companies alive -- the big banks only lend to SOEs so the investing public has looked for the next investment vehicle, and that's the stock market -- well it was until a few weeks ago.

What does this mean?  

Another government will try to slow the inevitable slide in stock prices; as one commentator recently said, China will need a bigger boat fund if they want to continue in bailing out the market, banning short selling is bound the be near the corner, liquidation of ETF (and certain connected derivatives) may also suffer.  I don't know how ETF are built in China -- in Europe ETF are mostly synthetic so that the ETFs don't actually own the underlying stock, rather the "arranger" enters into a number of complex derivatives transaction that generates the same return -- at a fraction of the cost... at least until the whole thing implodes.

China has been the engine of global growth for some years now, absorbing an increasing amount of available resources and keeping prices "up".  That now seems to be changing, the question is will China suffer the same consequences as Japan when that economy slowed?  One thing for sure, this bodes poorly for resource rich nation -- CAD watchers watch out -- the 0.70c to the US dollar is on the horizon...  Remember the CAD peaked at 1.09 to the USD, its now at 0.72c.  

Time will tell










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