China’s Equity Mania: How large is the economic risk?

The real economic consequence resulting from a severe equity market shakeout in China is likely to rather muted.

So far Chinese domestic stocks have continued to roar ahead, despite growing concerns from the authorities and recent tightening measures. Still, all bubbles eventually burst and there is no question that the developing equity market mania in China will experience a similar fate. However, a falling stock market is unlikely to inflict significant damage to the Chinese economy, for three reasons.

1. The correlation between China’s stock market and economy has historically been minimal.

2. The banking system still dominates financial intermediation despite the rising importance of the equity market.

3. The exposure of banks to equities is negligible, as financial leverage in the stock market is not allowed.

Bottom line: It is unlikely that falling stock prices will have a chain reaction in the financial system.

Technically speaking........

The FTSE-100 (6639) opened sharply lower on Wednesday but then followed Wall Street’s lead and almost managed to eradicate all of the day’s losses. We are ahead again today (up 37 at 16.00hrs). This sharp turnaround appears to suggest that the market is becoming immune to the prospect of rising volatility in the Chinese stockmarket, although the reality is probably that traders (particularly in the US) have reached the conclusion that the removal of some of the froth in that market might not necessarily be a bad thing - as long as it doesn’t lead to a crisis of confidence (and a concomitant drop in demand). Bottom line: The Chinese authorities might be new to ‘free markets’ but they do at least have the benefit of being able to avoid the mistakes made by others, so it would be unwise to assume that they will act like novices - and global investors are clearly indicating that they do not expect them to.

Equity Indicators 

CSFB have eight tactical indicators for equities which, according to a report today, are still largely positive in spite of the 11% rally in global equities since early March. 

6 out of 8 of their tactical indicators are neutral or positive. The 4 positives are: 

1. Corporate net buying is still five times average levels;

2. Equity sentiment is below average;

3. Earnings momentum has picked up sharply;

4. The advance/decline line is still trending up.

The two slight negatives have been:

1. Insider buying (but this is now trending up)

2. Risk appetite (this is now 0.7 standard deviations above average but the worrisome level has been 1.75 std or above)

Bottom line: Continue to climb that wall of worry! 

And finally.................Click here

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.