Category: Global Finance

The Chinese Stock Market is a Bubble

China Finance and marketThe figures and stories on China’s stock market keep getting higher and crazier. The Shanghai index is now up over 140% in the past year, while the Shenzhen Index is up 185%! Among the slightly more than 1,700 stocks on the Shenzhen Index, only a mere five have declined this year; and individual stock rallies of more than 500% “are not unusual.”

IPOs in China are so hot that recently a company seeking $2 billion attracted bids totaling $273 billion, virtually equivalent to the entire economic output of Hong Kong. Further, shares of the 144 firms that went public this year have averaged a return of 539% so far.

Valuations are looking frothy as the Shenzhen index now trades at approximately 44 times projected earnings, compared to the Nasdaq’s current 23 and the MSCI World Index of 17. The entire market capitalization of the Shenzhen index is now $4.7 trillion, surpassing the U.K.’s entire stock market value.

What’s driving the index to these nosebleed levels? It doesn’t appear to be fundamentals or an improving Chinese economy; rather, it is individual investors opening new brokerage accounts and trading on margin.

Newly opened brokerage accounts have spiked in recent months, while margin financing (borrowing money to trade) has also gone parabolic. A recent Bloomberg story recounted a 28-year old office worker in northern China who travelled 1,000 miles to set up an account in Hong Kong in order to get cheaper trade commissions and lower margin finance charges saying, “I can make more money if I can borrow more.”

Perhaps Chinese citizens have just gotten stock market fever and are getting caught up in the euphoria. Alternatively, it also appears the Chinese government actually had a direct role in creating this hysteria. Last August the state-run media started urging the Chinese public to put their savings into stocks, “espousing the wisdom and patriotism of owning equities.” The government has also reduced fees and now allows individuals to open 20 accounts instead of only one.

But that begs the next question, namely, why does the government want its citizens in the stock market so bad? According to Anne Stevenson-Yang of J Capital Research, a Beijing-based research group, there are two main reasons. First, a bull market will allow heavily indebted firms, many of them state-owned, to swap out debt for equity which they won’t have to pay back.

The second is to provide an alternative to the sagging Chinese property market. It wasn’t too long ago that Chinese savers and investors were stashing their wealth into empty apartment buildings, trying to earn a return or at least keep their principal safe as they didn’t trust the banking system. But the real estate bull market has run its course and now they are turning to the stock market as an alternative.

This is the unfortunate outcome of a country that continually tries to centrally plan economic growth and inflate its economic statistics. Instead of allowing real wealth producing activities to take place, which is messy and takes time and hard work from entrepreneurs, the Chinese government bounces from inflating one asset to the next in order to juice GDP numbers. Chinese citizens are then forced to play the same game in an attempt to preserve their wealth and earn a return on their money.

Chris Kuiper, CFA is currently a student and researcher at George Mason University pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.


Venezuela’s Currency Plunges…Again

The bolivar People exchange US dollars and Venezuelahas taken another sharp drop this past month, decreasing nearly 30% and falling as low as 423 bolivars per dollar, down from 279 at the start of the month as Bloomberg recently reported. The current exchange rate of nearly 400 bolivars means the currency has weakened 82% in the past year alone. This of course is the black market exchange rate, as the legal exchange rates still stand at 6.3, 12 and 199 bolivars per dollar (the government has instituted a three tier exchange system).

Unsurprisingly, Bloomberg noted inflation stood at 69% last December, but a recent report by investment bank Bank of America/Merrill Lynch indicates inflation may have reached just over 100% year-over-year this past April. Of course, the analyst of the report had to use both official and private sources to compile the data, as Venezuela’s central bank stopped publishing the consumer price index in December. Even more troubling is a recent analysis by the Cato Institute’s Steve Hanke who found that, using the principle of purchasing power parity, Venezuela’s year-over-year inflation will likely be 510%!

This is nothing new as the bolivar’s severe debasement has been going on since as early as 2011 (and even in the 80’s they were experiencing double-digit inflation already.) What is new according to the Bloomberg article is that the black-market rate is no longer tracking the so-called “implicit rate” which is the number of bolivars in circulation divided by foreign reserves. Starting last year, the black-market rate began to diverge sharply from the implicit rate and is now about three times higher.

Why? Venezuelans believe the debasement will continue far into the future, perhaps even at accelerating rates. As Bloomberg News notes, “To put it simply, it appears that Venezuelans have lost all faith in the bolivar and seem willing to pay whatever it costs for greenbacks.” Indeed, when the last vestige of faith disappears from paper currency, nobody wants to hold any of it at any price. Some people may wonder why you wouldn’t want to hold a currency that is “undervalued” compared to the reserves (such as gold) the country has in the bank to back the currency. Wouldn’t this be like buying a company that is trading for less than what it holds in cash? Yes, in a sense. But if a company is selling for less than the value of its assets or even the cash it holds, then the market is saying something – namely they expect the company to burn through most of that cash or assets, making it worth even less in the future. The same is true for Venezuela. Its citizens now believe its government will continue to print money and deplete any remaining reserves.

The bad news is this will continue to be a disaster for Venezuelans who have already been coping with food and essential goods shortages. But perhaps a silver lining is that the end appears to be near, which will hopefully bring about change and an end to their worthless paper money.

Chris Kuiper, CFA is currently a student and researcher at George Mason University pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.