Alice in Marketland

Is China Vulnerable To A Reverse Wealth Effect?

Xian, famous for its army of terra cotta warriors discovered around an imperial tomb, was briefly capital of China a couple of hundred years BC. Recently there, friends took me to spend an evening in a new attraction park devoted to the Qin Dynasty, built at great expense by a Taiwanese entrepreneur.

Most antiquities in China were either destroyed or badly damaged during the Cultural Revolution. As a result, even official museums are a mixture of history and entertainment galleries, with (good) reproductions easily outnumbering originals.

The park, no exception, is an impressive realization, midway between historical re-creation and Disneyland. For example, upon coming out of the huge restaurant, I came face-to-face with a bronze statue of French soccer star Zinedine Zidane, clad in emperor clothes (proof below).

A few days later, in Beijing, it occurred to me that, before long, I might be able to have my picture taken next to a bronze statue of Warren Buffet.

The level and breadth of stock market speculation in China has recently reached spectacular proportions. In Beijing, I had a drink with a former guide, who had taken me to visit poor farmers’ villages a couple of years ago. She and her husband then made up a modest young couple, though one with some promise as he was training to be a lawyer. But their monetary means were limited, especially since his parents (as is often the case) were living with them.

Clearly, they now are doing better. He has established his own practice and she is thinking of buying her own small, city car. I mention this example because my young guide is anything but a candidate for stock market speculation. Money, for her, comes after many other, more idealistic motivations and goals; she is naturally thrifty, with a good head on her shoulders, and inclined to plan her life carefully. Yet, knowing what I do for a living, she admitted sheepishly: “I recently bought a stock”. Then, after a pause: “I made 60%”.

As can be seen in the following graph, she’s not alone.

Source: Factset

Savers of all walks of life are pouring into the stock market. The total number of A-share accounts in China is now approaching 90 million, according to the China Securities Depository and Clearing Corporation, 15 million more than a year ago. The number of new accounts opened by retail investors only in the first three weeks of April reached 2.8 million vs. 3.1 million in all of last year.

By chance, I had occasion to meet the CEO of one leading mutual fund company and the Chief Investment Officer of a newer one, about three weeks ago. Both complained about the irrepressible inflow of money into their funds. One of these funds is less than five-months old and has already received 1 billion RMB ($130 million) in subscriptions. They would like not to invest all that new money, but it is their job to do so: since our meeting, the Shanghai stock market already has tacked on another 15%.

One of these managers mentioned that poor quality shares are up even more than the market and, after falling sharply in February, are now back to a 100% valuation premium over the shares of equivalent companies trading in Hong Kong (H-shares). For better-quality shares, the premium over Hong Kong valuations, which had shrunk substantially in February, is now back to 60% or more.

Meanwhile, those institutional investors who can sell are apparently doing so. This is particularly the case for the National Social Security Fund, which is not allowed to hold more than 30% of its assets in equities and was recently at 39% as a result of the stock market boom.

One can argue about whether there is a Chinese stock market bubble, or whether the current valuations are justified. I tend to feel that this is the case but I saw no sign, during my trip, of economic overheating. And, except for pollution (see my recent papers) and exposure to the US consumer, there are no obvious reasons to expect a significant economic slowdown in China. In fact, Andy Rothman, of CLSA, argues that Chinese GDP figures are false and that, after a slowdown in the last two years, the Chinese economy is now re-accelerating. So far, he has been more often right than wrong about what is really going on inside China.

Yet, observing all these day-traders, in an economy where the stock market has become a symbol of the country’s wealth creation and a constant fuel for consumer optimism makes me worry. Just when the nascent consumer sector is counted on to relay exports as a growth engine, a significant stock market re-adjustment could well carry a nasty blow to consumer confidence.

So far, however, all this only proves that I will always find something to worry about.

François Sicart, back in Paris
May 8, 2007

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