June 28, 2015

A Bubble Of Epic Proportions

Readers wondered this morning, “How about that Chinese stock market?” A reply, “Didn’t we talk about it enough Friday? It was an expected correction that the Chinese are making sure goes no further.”

The Hong Kong Economic Journal. “Some mainland investors have borrowed money against their US real estate assets in order to invest in China’s red-hot stock market. The size of that investment could be as much as US$30 billion. Those investors are facing increased risk from the imminent US rate hike.”

“Meanwhile, the mainland equity and housing markets are out of sync with a slowing economy. It remains unclear whether A shares will continue their run-up after a deep correction in the past few days. The market is no longer cheap. In fact, it’s very expensive, with some small and medium companies hitting P/E ratios over 70 times. Heavyweight stocks are make more sense at 25 to 30 times P/E. The bull market has sparked all sorts of speculation.”

The Washington Post. “Shanghai Duolun Industry, a Chinese real estate company, managed to win over investors with a little re-branding in May. In the midst of a technology stock boom, the company decided to change its name to ‘P2P Financial Information Services Co.’ The company didn’t actually develop a peer-to-peer lending business — it just bought the domain name — but its shares jumped 10 percent anyway.”

“‘P2P Financial Information Services Co’ wasn’t alone in this strategy. One Chinese floorboard company doubled its share price by shifting to online gaming. A hotel group became a high-speed rail company and a ceramics specialist re-branded as a clean-energy group. Investors rewarded these decisions.”

“Here are five facts about China’s stock market bubble — each of which help explain why the bubble arose and what might happen to it. In just 12 months, Chinese stock markets have created enough value to give every person on Earth almost $900. This is a bubble of epic proportions. In 12 months, Chinese stock markets rose enough to create $6.5 trillion of value. It’s hard to picture, but that’s a stunning amount of money. It’s the equivalent of about 70 percent of China’s GDP in 2013, and about 40 percent of the total value of the New York Stock Exchange. It’s enough to pay off Greece’s debt 20 times over, circle the Earth 250 times with $100 bills, or build 43 International Space Stations.”

“People often say that stock markets follow the ‘greater fool’ theory – even if a stock is irrationally overvalued, it still might be worth purchasing if there is another fool out there willing to pay a higher price. That may now be the calculus for many Chinese stock investors. As high as valuations are, novice investors keep rushing into the market. Just last week, 1.41 million new investors opened stock accounts, according to Reuters, a similar number to each of the two weeks before.”

“A survey last year showed that that two-thirds of Chinese investors haven’t completed high school. Even Chinese farmers are giving up tending their fields in order to tend their stocks. And many investors are young: According to Chinese-language media cited by Foreign Policy, over a third of China’s 100 million investors are 30 or below.”

Investors Business Daily. “At the moment, Chinese regulators appear content with letting the correction take place. But the question going forward: How long will the correction continue before it turns or China’s government steps in to prevent a panic? A continual, cascading collapse of Chinese stocks ‘would have an impact on the broader Chinese economy and how foreigners view China as an economy and as a market,’ said Sung Won Sohn, a professor at California State University Channel Islands. ‘I don’t think the market is going to stop declining any time soon.’”

The Epoch Times. “If printing money cannot maintain growth, will issuing stocks be able to guarantee growth? We Chinese are now caught in a state of elation. There is no use to talk to anyone, as everyone is thinking about how much stocks have gone up each day. It is like being at a happy feast. The noise of the feast covers up the fundamental issue. Perhaps after the bubble has burst, we can talk about innovation. Right now, no one is in the mood to talk about innovation.”

“Some people say to me: ‘Professor, you study western economics. Chinese economics and western economics are not the same.’ When we talk about science, do we divide science into East and West? If we were to follow such a path, the concept of the cost of capital would be completely turned upside down. You think you can get money from investors for zero return. Who will bear the stock market costs? Investors, of course. Companies have obtained money. When stocks fall, investors suffer heavy losses. Those who participate in creating the bubble may not think about that.”

“Wealth is not generated in this way. In the past 200 years, wealth was not created by stock market bubbles or central banks issuing money. How is wealth created? That is a question each individual, each enterprise, and the government should ask themselves; it is the basic question in economics.”

Bits Bucket for June 28, 2015

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