Chinese Red-Chips Show Signs of Fatigue

by Gary Dorsch, Global Money Trends. August 11, 2009

In a little more than nine months, the pendulum of trader sentiment in Asia has swung radically, from the extreme levels of panic and fear to the opposite side of the coin - hope and greed. Now, there is anxiety that asset bubbles are forming in the Asian tiger markets. At the epicenter of the Asian sphere, the Shanghai red-chip index has doubled in value from its lowest levels last November – surging higher in a parabolic fashion, often a tell-tale sign of a bubble.

Other stock markets in Hong Kong, India, and South Korea have also surged sharply higher, hitching a ride to the Shanghai bandwagon, and property prices are also rising from Seoul to Mumbai. Asian central banks are pursuing ultra-easy money policies to boost domestic spending in order to offset the damage to the export-dependent region from the collapse in global trade. In turn, upbeat stock markets in China and India are helping to underpin hopes for stronger economic growth.

On August 9th, Chinese Premier Wen Jiabao reaffirmed that the ruling Politburo and the People’s Bank of China, (PBoC) would be “sticking to the proactive fiscal policy and moderately loose monetary policy is because we are facing many difficulties and challenges,” he declared. South Korean President Lee Jyung-bak said on July 27th, it is too early for the Korean central bank to exit from an accommodative policy.

In order to jump start the world’s third largest economy into a higher gear of growth, the PBoC has allowed the China’s M2 money supply to expand at a record 28.4% annualized rate. Beijing scrapped lending restrictions on bank lending in November, and since then bank loans outstanding have soared by 8.5-trillion yuan, ($1.25-trillion), equal in size to roughly 27% of China’s economy.

Along with China’s 4-trillion yuan ($586-billion) spending plan, earmarked for the construction of roads, railways and airports, the combined fiscal and monetary stimulus equals a whopping 42% of the size of China’s economy. About 1.16 trillion yuan ($170-billion) of Chinese bank loans extended in the first five-months of this year were clandestinely channeled into the stock market. That was equal to roughly 20% of all loans extended during that time period.

Chinese leaders are implementing the Greenspan – Bernanke blueprints to forestall a normal economic recession by flooding the markets with yuan, which creates bubbles. Indeed, Chinese banking regulators warned last month that credit was being channeled to the property sector and the stock market, creating the risk of an asset bubble instead of supporting small businesses and the broader economy.

The Shanghai red-chip index has been on a wild rollercoaster ride, plunging by 65% last year as the global financial crisis, and collapse in Chinese exports helped to burst a bubble formed by a five-fold surge in 2006 and 2007. This year’s 90% upward surge to the 3,450-level has pushed Shanghai’s P/E ratio to 34-times forecast earnings for 2009, while the Shenzhen market’s small-cap shares are at 45-times. Yet earnings growth for all of 2009 will still stay in negative territory despite expected improvements in the third and fourth quarters.

After doubling in value over the past eight months, Shanghai red-chips showed the first signs of fatigue over the past two-weeks, including a 5% slide in a single-day and a 7% slide over four-days before finding buyers at the 3,220-level on both occasions. Thus, the 3,220-level is seen as the key pivot point, which if sustained could encourage speculators to jump into red-chips for short-term gains, or if penetrated with a selling spree would signal a significant market top pattern. In either case, the gyrations in Shanghai are expected to ripple through the Asian sphere, and in turn influence key commodities such as copper and crude oil.

Beijing has taken modest steps to cool the Shanghai rally with the resumption of initial public offerings culminating in last week's $7.3-billion offering by China State Construction Engineering, the world’s biggest IPO in a year. Also, PBoC deputy Su Ning signaled on August 7th that China's bank lending would slow in the second half, and that monetary policy would be calibrated with fine-tuning via market tools.

Thus, in the opinion of the Global Money Trends newsletter, Beijing appears to be growing wary of any further advance in the Shanghai red-chip index and might resist speculative forays that would lead to a dangerous bubble. Instead, the ruling Politburo which controls the money spigots, and reigns over local banks might be attempting to engineer a sideways consolidation pattern for now. A possible 10% to 15% correction for the Shanghai index wouldn’t be a cause for alarm.

The outlook for the Chinese imports is a key driver for speculators and hedgers in the global commodity markets. China bought record volumes of crude oil, copper, and iron-ore this year to meet the demands of its $586-billion infrastructure spending. Oil imports jumped 18% to 4.6-million barrels per day in July, and iron ore imports jumped 5% to 58.1-million tons. The second-largest energy user and biggest iron-ore buyer spent a combined $13.8-billion on the commodities last month.

Oil refiners and steel mills are believed to be stockpiling commodities in anticipation of rising prices. But speculators are also bidding for iron-ore, the key ingredient for steelmaking, lifting the price +9.2% higher to $104.10 a ton last week. Iron ore inventories at China’s major ports have risen 29% to 75.2-million tons. China is now importing more iron ore from Brazil and scaling down purchases from Australia. Brazil’s Vale is now selling around 70% of its iron-ore to China.

Chinese steel output surged 13% in July to 50.7-million tons, the third consecutive record monthly high, sending Chinese steel prices 30% higher since April. With the Chinese economy bouncing back so rapidly, it’s on pace to overtake Japan to become the world’s second largest economy in dollar terms by the end of this year. The recession has brought forward the time when the non-Western economies produce more than half of world GDP, for the first time since the middle of the 19th century.

China bought one-fifth of Australia’s total exports in March, and its imports are 80% higher than a year ago, cushioning the Australian economy from the worst effects of the global recession. On August 7th the Reserve Bank of Australia (RBA) pointed to the strength of China with its insatiable demand for natural resources, helping to underpin Australian exports even as global trade slumped, and justifying the end to the most aggressive rate cutting campaign of modern times.

The RBA is the only central bank in the developed world that is thinking of raising rates. On July 29th, RBA chief Glenn Stevens hinted he might not wait for signs that the unemployment rate has peaked before hiking the cash rate. “I’ve never seen written down or heard in discussion some rule of thumb, that says we wait until unemployment is peaking before we lift the cash rate,” Stevens said.

Australian T-bill futures traders in Sydney have already priced in 75-basis points of tightening above the 3% RBA cash rate within the next six-months. “We can much more easily imagine upside risks to the inflation outlook, to balance out the downside ones, than was the case six months ago,” Stevens warned on July 28th. “These risks have been reasonably contained so far in Australia, but it would be prudent not to push our luck here,” he added. The Australian dollar hit a 10-month high above 84-cents, bolstered by rising iron-ore and base metal prices and sliding T-bill futures which support ideas the RBA would hike rates earlier than previously thought.

Of course, opinions in the schizophrenic currency and fickle global stock markets can suddenly turn on a dime. After a doubling of the Chinese stock market’s value, any unexpected bad news or signs of a deflating bubble can quickly trigger havoc in related equity markets throughout Asia, including base metal miners in Australia and Brazil, which in turn can rattle the Aussie dollar and Brazilian real.

On August 10th Mark Mobius, executive chairman of Templeton Asset Management, predicted global stocks will drop as much as 30% following their recovery from last year’s rout as companies take advantage of the rebound to sell more shares. “When you have these rapid increases, almost without correction, you will definitely have a correction at some point, so we can expect a lot of volatility. Increases of 70% will be followed by decreases of 20% to 30-percent,” Mobius said.

Gary Dorsch

© 2009 Gary Dorsch

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