Falling stock markets, even in China – some thoughts

Now that the stock markets worldwide are seeing a big correction, the Chinese stocks start following them. Finally. Over the past year I have watched in amazement what was happening in the market. Although not everybody agrees, I felt Chinese stocks were completely overvalued (mainly based on multiples). The main reason the prices kept going up, was because more and more people entered the market, blinded by the possibility of getting rich. People were putting their life savings in, without being aware of the fact that what goes up can also go down. As an economist with a major in corporate finance, I felt a bid sad watching the ignorant crowds on People’s Square on weekends, listening to investment experts with laptops showing off their profitable investment strategies. None of them ever heard of efficient markets, let alone the world bubble.

Shanghainese have the reputation of being very thrifty, but when it comes to the stock market they seemed to jump in without thinking twice. Once my driver started to invest in the market, I knew the bubble had to burst soon. I heard stories about retirees putting all their money in the market, and just last week I came across an article about Chinese students investing their university fees, instead of paying their tuition. How many more signs are needed to show that the market is overheated? But people kept investing.

I hope for the small Chinese investors that the markets will stabilize, although fundamentally there is still a big downward potential. Imagine what would happen if all these people would lose most of their savings, that could be a threat to China’s stability. For that reason I believed that the government might step in if prices would fall too quickly, in order to stabilize the economy. But now that the markets are following the markets outside China, I am not so sure anymore.

The main reason that China’s stock market went up so much over the past 2.5 years (about +450% right now, +600% early November at the top) is that Chinese can only invest in companies listed in China. Once the index started to climb in mid-2005 it was basically a self-fulfilling prophecy: people made money, bragged about it and others started to follow. There was no other place to invest in stock anyway, even Hong Kong shares are not available to mainland Chinese investors. Therefore valuations of companies in Hong Kong are very different from valuations of the same companies listed on a China exchange. And that’s also the risk: once investors start to pull out their money, others will follow. And then the ride can go downhill fast, because fundamentally the Shanghai stock exchange is still far overvalued.

I hope for the Chinese investors that there will be a bottom in the market soon, either based on perceived fundamentals or on people starting to buy back shares at lower prices. At that point the market could even start rising again, because most investors do not understand why markets move as they do. If people start to make profits, others might follow again. Maybe the Chinese government should start slowly open up investment opportunities outside China, to avoid a second China-only bubble.

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  1. Hello Marc, an article in Shanghai Daily mentioned last week, that the most of “investors” at the biggest open-air casino (which is what Shanghai bourse has become, in my opinion) are individuals. I can neither recall the precise number, nor did I a research what this ratio is at mature markets. However, my Chinese assistant is pretty cool-headed about the recent situation:”I know I bought a stock worth 2 RMB at 8 RMB, but since it has raised up to 11 RMB when I sold it, I am still happy with the profit.” And as for the poor guys, who will not make it out in time, one can sympathize with their grief about life-savings, but on the other hand, as someone said, “Experience is the best school-only tuition can sometimes be very expensive.” Even in mature markets there are hypes and bubbles, and investors, who lost, usually do not repeat their mistake, if they are lucky enough to have the second chance. – Second, evening news tend to replace rational thinking with emotions. Of course, I am human and I do feel sad seeing in news a family, who has just lost an UNINSURED house in the disaster, (“Look into sad eyes of these children, where are they going to live?!”), but if they ask for government support and meddling, that’s wrong. Their father has been making his (wrong) choice all the time, choosing short-term gain over long-term covering of the risk. The same with the gamblers. I am not an economist, but in my opinion from the long-term point of view it is the best if Chinese government only use standard macro-economic measures, or allows investment in other markets and does nothing else. Why should others pay the bill of those people, who replaced their usually VERY good Chinese business intelligence and that useful mistrust and caution (“How can you charge me 7,5 for this piece of chicken, it should be only 7,3!!!”), with greed? Last: I also more than agree with you, that if Chinese companies were allowed to invest more freely at more mature markets, that would lower the risks also for individuals, who might participate and channel their money through investment companies to where it would yield maybe more modest returns, but at the same time it would also lower the risk. (Sorry for a lengthy comment.. 🙂

  2. Thanks for the lengthy comment. I agree that we should not really feel bad for the investors that are losing money in the stock market this week. They should have done their homework before investing, but the problem was that most of them have no way to get unbiased information.

    The risk I see is that there may be potential unrest if people lose all their money. However, if the stocks lose 1-2% per day (like happened this week) it is still OK. People can get out when they want to, it’s better than if the stock goes down 10-20% per day (which cannot happen, as there is a 10% downward “ceiling”).