Thursday, July 09, 2015

China's volatile equity market and prospects for calamity

China's equity markets finally regained their footing in trading yesterday.  Their performance in the past six weeks has been horrific but, that included, their performance over the past 12 months remains notably positive.  Still, it seems here that China is the biggest issue out there for global markets. Greece gets more attention at the moment but it is such a piker compared to China.  With all of the rapidly announced government support, China may well rebound now, but that does not mean that all is well.

Many investors with a long term positive view of China remain committed, pointing out China's GDP growth rate is still around 7%(the envy of the developed world), its excess currency reserves are substantial, and its middle class continues to grow, though somewhat less robustly.  The question is whether all of that really matters to a grossly overvalued stock market.  In the U.S. in 2000, as the technology bust began, the government had a balanced budget, unemployment was low, and prospects for growth were presumed to be high.  The price earnings ratios of most stocks, even price to no earnings ratios, were at historic highs, and once the decline began nothing could stop a significant downturn in equity markets, and while the drop was brutal in technology stocks, it was also widespread and significant as the tech bubble sucked liquidity from the market in general.

The thought occurs here that China could ultimately face what would be a combination of the U.S. tech bust, the U.S. 1989 - 1990 commercial real estate crash, and the U.S. 2008 - 2009 residential real estate bust and financing fiasco that led to the so-called Great Recession.  It is a fact that commercial real estate is substantially overbuilt in China, even as new building continues in various areas of the country that still aspire to the growth of the capital and the coastal cities.  Remember the "see throughs" of the late '80's and early 90's in the U.S.  They are already built in China. Residential housing is also in a boom that is far beyond the reach and capacity of even China's growing middle class.  Recently it was reported that the Chinese government is already buying up empty residential developments and selling apartments at significantly reduced interest rates and prices to those who are forced out of their homes by continued development --- business districts, dams, roads, trains, and other infrastructure projects to make China more upbeat to the world.

All of this is not to suggest that China is facing some economic disaster now.  Not now and not longer term, but there is definitely a hump to get over at some point, and the pain is unknowable. They are a party dictatorship.  Did I actually write "party".  Yes, I guess so when one looks at overwhelming evidence of Mao party young people with their amazing cars and vastly expensive party lifestyle. Their behavior is in fact repulsive, even more than the Russian oligarchs in London. Widespread word of their behavior on the internet, when accessible, is certainly to be found in China. As in the U.S, this news and behavior is not positive for the majority of the aware people, or should it be said minority in both cases.

China has resources that are substantial and they have the political and military will to avoid anything that overtly disrupts the public, anything that could upset the government's unbending autocratic rule. Unfortunately financial markets that openly trade do not necessarily respect mandates, and given that the Chinese equity market is substantially retail, the worry is that the expected middle class growth will retrench.

China is an opportunity to be watched for more reasons than one.  It can be expected that there will be more news to come from China and what happens there is far more important for global markets than the powerful Japan was in the 1980's or of course Greece today.


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