Shanghai surprise is coming, warns CIBC

Although the CIBC Economics Department says “the eventual correction/burst of the Chinese stock market would probably be the most anticipated burst in the history of financial market bubbles,” I still found these figures fascinating. Here is their report from last Friday:

“A stock market that rises by 200% in 18 months is not necessarily a bubble. But a stock market is a bubble when:

– The value of shares traded daily in this market is double the value seen in stock markets twice this size

– Its P/E ratio is three times higher than its neighbouring countries

– 80% of fourth-year students are also stock investors

– 75% of the market is “naive money” – held by individuals, and only 25% is held by institutional investors

– 400,000 stock accounts are opened daily

The Shanghai stock market is a stock market without a country. Valuations do not reflect the shape of the economy and have no correlation whatsoever to corporate profitability. It’s a question of when, not if, the Shanghai market will correct. And when it does, not too many people will be surprised. The eventual correction/burst of the Chinese stock market would probably be the most anticipated burst in the history of financial market bubbles.

The more interesting question is what would be the ramifications of such a correction on global equity markets. We already have had two dry runs. The 9% plunge in the Chinese stock market in late February led to a domino effect in most other markets. The S&P 500 fell by more than 3%—its steepest drop since 9/11. The TSX dropped by more than 2.7%, the Nikkei fell by almost one percent and the British FTSE, the German DAX and the French CAC fell by 2.2%, 2.0% and 2.6% respectively. But the second drill on May 30th yielded totally different results. The Shanghai index fell by 6.5%, following the increase in the stamp tax on investment, but the response of global stock markets was a collective yawn, with the S&P 500, in fact, reaching a new high on that day.

Global markets may be more linked than ever before, but investors are growing accustomed to wild swings in Shanghai. At the heart of this rising indifference is the realization that the wall of capital constraints that Beijing maintains on its currency, while contributing to the current surge in valuations, also means that the mainland stock market is an island unto itself, detached in any real sense from other markets.

And despite the recent boom, the stock market is still a relatively small part of the economy, even by the standard of emerging markets. The market cap of China’s stock market represents just over 14% of GDP—one-fifth the size of the Indian stock market and a quarter of the market cap of the Brazilian market. And any negative wealth effect on the consumer due to a correction will be largely offset by the more than US$2 trillion in liquid savings held by Chinese households.

Global equity markets will easily withstand a Chinese stock market correction. But the millions of housewives, students and retirees that are now entering the market will not fair as well.”

MRM