Anecdotal Asides and Questions Begging Answers

by Rob Kirby, Kirby Analytics. June 4, 2007

The state of China's equity market has made news again today with a steep drop of the Shanghai Stock Exchange of over 8% being widely reported in the mainstream western press.

China shares tumble as panic spread
Mon Jun 4, 2007 6:29AM EDT
By Andrew Torchia
SHANGHAI (Reuters) - China stocks tumbled 8.3 percent on Monday in their second biggest drop this decade, erasing $340 billion in market value and extending big losses from last week after the government hiked the share trading tax to cool a feverish bull run.
In an apparent attempt by authorities to restore confidence, front-page editorials in official newspapers tried to reassure investors the market's medium- and long-term outlook was still positive, and that the tax hike was merely aimed at speculators.
But that failed to stop selling by many of the anxious and often inexperienced individual investors who had jumped into the market in recent months for what seemed like easy money...

I'm not going to question whether or not the Shanghai Exchange "took one on the chin" today – but I am curious enough to ask the question, "Was the steep drop fundamentally warranted or not?"

The reason[s] I'm curious goes like this:

If the steep drop WAS NOT fundamentally warranted, this sell off represents a GREAT entry point to establish new "long positions" in Chinese equities. If the drop was warranted – what was the basis?
Understanding the basis [reason] for such steep declines would possibly offer valuable insights as to what "markers" or "tell-tales" one might want to be aware of in other equity markets as potential warnings to either reduce positions or "get out of the pool altogether," so to speak.

The chart above appears to going parabolic, doesn't it? But let's consider that:

"The Shanghai and Shenzhen stock exchanges list more than 1,200 companies with a combined market capitalization of US$500 billion (2005) (30% of GDP, see list of countries by GDP (nominal)), rivalling the Hong Kong Stock Exchange as Asia's second-largest stock market behind the Tokyo Stock Exchange."

While the notional value [U.S. 500 billion] is very dated – it’s the percentage of GDP that I would like to draw everyone's attention to – namely and explicitly, the market capitalization of the Chinese Stock Market as a percentage of GDP – 30%.

Now, let's consider that Chinese GDP data are "suspect" – owing to their arbitrarily and, as some would argue, artificially [manipulated] low currency "peg" to the U.S. Dollar – and as a result – Chinese GDP data are, in fact, under-reported.

How often do we open our newspapers or turn on our T.V. sets to hear the "bleats" from the talking heads that the Chinese equity market is a "bubble looking for a place to burst"?

How many times have these dire prognostications been served up THE reason why strategic commodities [like gold, crude oil or natural gas or base metals] have taken an OTHERWISE unexplainable "swan-dive"?

Over-Valued or Under-Valued – It Depends On Whose Ruler You Use

Now, I'd like everyone to consider the market capitalization of U.S. Stock Exchanges:

NYSE: 22 Trillion

NASDAQ: 4 Trillion

With U.S. GDP running around 13 Trillion, we can CLEARLY see that stock market valuations [combined NYSE and NASDAQ] are running at 26 Trillion – or 200% of U.S. GDP.

By this metric – it would appear that the Chinese Stock Market still has A LOT OF ROOM TO GROW – despite its recent "parabolic" rise.

So whose stock market is over-valued now?

Anyone from the mainstream western financial press want to answer that question?

Today's Market

Overseas equity markets [for the most part, anyway] shook off the jitters in the Chinese market as Japan's Nikkei Index managed a gain of 14 points to 17,973. North American markets also ended in positive territory with the DOW ahead by 8.20 to 13,676.30, the NASDAQ gaining 4.37 to 2,618.29 and the S & P adding 2.85 to 1,539.20. NYMEX crude oil futures gained .99 to close at 66.07 per barrel.

On foreign exchange markets, the U.S. Dollar Index shed .29 to close at 82.00.

Interest rates a couple of basis points easier across the curve with the benchmark 5 yr. bond ending the day at 4.91% while the 10 yr. bond ended the day yielding 4.93%.

Precious metals ended the day mixed with COMEX gold futures ahead by .20 to 671.30 per ounce and COMEX silver futures giving up .05 to 13.74. The XAU dropped .93 to close at 141.49 and the HUI shed .31 to end the day at 342.53.

On tap for tomorrow, at 10:00 a.m. May ISM Services data is due – expected 56.0 vs. prior 56.0.

Wishing you all a pleasant evening and happy investing!

Rob Kirby

* Acknowledgement: The inspiration for today's Market Wrap comes from a market savvy poster on the VoyForums who uses the "pen-name" of Gila Bob.

* Correction: In my last Market Wrap, I improperly stated that 1 Metric Tonne = 35,274 Ounces. In the context of the piece I wrote, I should have stated that 1 Metric Tonne = 32,150 Troy Ounces. There is a difference between "regular" ounces and "Troy" ounces. While the correction alters the math in my last piece – somewhat – it DOES NOT meaningfully alter the spirit or intent of what he piece was attempting to illustrate. Special thanks to reader G.P. for pointing this out.

Rob Kirby

Contact Information

Rob Kirby | Proprietor, Kirby Analytics Newsletter - Proprietary Macroeconomic Research
Toronto, Ontario, Canada | Observations | FSU Editorials | E-mail