Shanghai, China update

Shanghai feb 16 2016The Simple Truth About China’s Market - Bloomberg Business - Google

We view the rise of the Shanghai index above 5000 last year as a B-wave, a correction in other words. Consequently we expect the entire rise, and perhaps some more, to be retraced. We have heard as many excuses why this is not an overvalued market as we heard when the Nikkei traded at a p/e of, I believe, something like 70X. Other arguments are , of course, that the p/e is only one out of many metrics or that you have to do it looking forward rather than backward which puts you into a circular argument.

The reality is, according to “the Simple Truth” as per Business Week/ Bloomberg is that the p/e, even after this almost 50% drop, is still at 57X. Even if we give China a p/e equal to the average/mean of about 17x and add 7% growth, we get about 24, say 25. That is roughly, very roughly, one half of where it is now. The implication is that if the p/e were to drop to a still high but “normal” level, still double Hong Kong’s or Canada’s, the Shanghai index could fall to about 1400, besting it’s 2008 low marginally. Since this index comes from 6000, 1400 would be about 1/4 of the peak value which is not substantially different from what the Nikkei actually did during the first 13 years of it’s drop. We are great believers in the adage that there is seldom something new under the sun. For your convenience, we repeat our blog of June 26, 2015;

Shanghai Composite Index june 26 2015

Shanghai, update

Then, 21 June 2015, and now charts as usual;

Shanghai Composite Index june 26 2015shanghai aug 24 2015

We use Bloomberg so that it includes today’s 8% slide.    We always expected that problems could emanate from China. It is after all the “new world” of today despite being one of the oldest countries on earth. Repeatedly we have expressed our amazement at what is going on there (see previous blogs). Colossal misallocation of capital is the fundamental cause plus, perhaps, a thoroughly misguided notion that the central government can do anything or correct what might be going wrong.

In our opinion at the heart of the problem, and this is true for all central bankers, lies an incorrect notion of what wealth really is. If a farmer plants and harvests his grain he ends up with a silo full of the stuff. This is physical, it is there and does not just evaporate. If, on the other hand, an investor buys stock which is then goosed up by central bank policies (300% in a year in this case), no wealth has been created un till the gains are harvested. Unlike with the grain, the process of harvesting destroys the wealth at more or less the same speed as it was supposedly created. In short nothing was ever accomplished other than the creation of a delusion. An individual can, of course, make a killing but collectively that is simple not possible, and China is nothing if not one big collective.

    Interestingly, the human mind is extraordinarily biased to the upside. Nobody complains when this index rises 300 to 600% in one or two years. But when it goes the other way something has to be done to stop the bloodletting. Short of creating the same conditions in perpetuity into the future, that gave rise to the gains,  that is the same growth, the same interest, the same everything, it is not possible to keep the illusion going.

There is still a long way to go before this is over. Essentially we are looking for the 1000 level. At this rate we could be there early next year. Our best guess is that we are presently in the 3d wave of wave 3 of C in a large, multi-year flat. The target is usually the 4th wave of previous degree. Please also note that “overlap” has already occurred which pretty well eliminates any possibility of this being a 5th wave to much higher levels.

Shanghai, on its way?

Shanghai july 9 2015

So the Shanghai index was down roughly 34.6% in less than a month, a good start but nowhere near even the first target (see previous blogs). That represents, from what I have read, something like 3.8 trillion dollars. A lot even for the 3d largest economy – Europe and US are a little bigger. The Chinese must have learned a lot from the Fed. in terms of manipulating the market. They are going a few steps further and are about to shoot those very malicious sellers of stock. What they do not seem to grasp, together with Chairlady Yellen, is that stock markets do not create wealth directly, they only do so indirectly by providing a financing vehicle for companies that can then go on and do their business. In a manner of speaking the stock market is more like a poker game the collective value of which is determined by the size of the wallets of the individual participants and their willingness to gamble. You are not supposed to leave the table when you are ahead, that is bad sportsmanship and frowned upon. But unlike a poker game stock market values can become bloated as the value of the chips change with each bid or offer. The 3.8 trillion and much more, never actually existed and can therefore never be cashed in collectively. Once that is understood things can become a lot worse.

By the way, Greece’s government liabilities amount to something like 340 bln dollars. Compared to China that is pocket change.

Shanghai update

Shanghai Composite Index june 26 2015

All is well in China, for the moment. If you look a little closer however you will see that this index is down about 20% just in the last month. What goes up, must come down appears to be the prevailing philosophy, that is if there is any philosophy at all. This market resembles a casino more than any other. EW works when a large numbers of people pursue their individual instincts. In a collective mindset it may not work the same way. In any event, if it does, the above depicts what might happen. The main catalyst would probable be Schumpeter’s constructive destruction in the context of colossal misallocation of capital and the resulting overcapacity.