China: What a Real Bear Market Looks Like

While the Chinese stock market bubble was brewing, a lot of people ignored it and frothed at the mouth about the over-valuation in the US market.

In keeping with that odd behaviour, while the US market has now fallen less than half the distance of the Chinese market (from their respective October 2007 tops), most people are more concerned about the US markets and again are ignoring the very real and brutal bear market in China.

Part of the explanation is that the US markets are obviously much larger and have more significance on the world stage, but still, a bear market is a bear market. And over in China they are grappling with a big one.

Bubble, Bubble, Toil & Trouble

The Chinese stock market has gone through bubbles before. This time it only multiplied by a factor of 6 in less than 2 years!

But that’s nothing compared to 1991, when it multiplied by a factor of ten in about a year. Remarkably, this recent mania was so strong that it shrugged off a trading stamp tax increase last summer and continued to rally for a few months. Usually such state manipulation would have meant a quick death to the mania.

Below is a graph showing the S&P 500 and the Shanghai Index since March 2003, the bottom of the last bear market.

Since the bull market in Chinese shares lasted longer than most predicted, it is safe to say that the bear may last longer also. The next level of support is around the 3000 level. After that, the resistance levels from 2000-2001 will come into play at the 2000 price levels.

Probably the best timer of Chinese stocks has been the editor of the newsletter, Cabot China & Emerging Markets Report. The newsletter's virtuoso performance in BRIC emerging markets brought it the trophy of the best newsletter in 2007. For the record, it turned negative in November 2007 right after the top and is continuing to stay away.

The editor, Paul Goodwin, uses an extremely simple way to enter and exit the market: 50 day and 25 day moving averages of Halter USX China Index [HXC]. That’s it. Trading doesn’t have to be complicated.

Chinese ADRs
Although there are quite a few individual Chinese ADRs trading on US exchanges, the only way that I know to actually trade Chinese equities (the A shares) is through the Morgan Stanley A Shares Fund (CAF). It has fallen from almost $61 in October 2007 to its current price in the low $30’s.

As a trading vehicle it is an imperfect one because it doesn’t track the Shanghai index very well. But unless I’m mistaken, it is the only way to get your hands on those A shares from outside China.

Comments

[gogreenback]

CAF trades at a 16% discount to NAV, the optium time to purchase was Jan. 08 when it traded at a 30% discount to its net asset value.

[rlirph]

You are right that the only way for foreigners to participate in the A share market is through CAF. However, the A share is relatively expensive to the identical cousin, the H share which is readily available in Hong Kong.

What we are seeing is that even though China has a closed capital market, the market force is rebalancing the premium between the A share and H share. If you look at China Life, Ping An Insurance, China Railway Construction, and several others they are now trading at similar prices in Shanghai as in Hong Kong. However there are also a few companies such as CHALCO and PetroChina which are still trading at 70%+ premium in the A shares.

I would expect in a short time the price differential will be reduced to 10-15%. For that reason I do expect the A share still has some room to fall.

If you look at PE ratio, the A shares have been trading at PE 60+ last year. Now it has fallen to 27 and the Shanghai Composite Index closed at 3223 today. If the index drops another 50% to 1612, the PE ratio will be 13.5.

I am seeing that the A share is trying to build a bottom around 3100. If that fails it may drop all the way to 1600-1800. At that levels. the China stock market is truly attractive indeed!

[Everyday Finance]

Best bet here is to stick with the true, quality earnings companies and avoid the rest since their earnings are not sustainable. BIDU and CHL are true growing companies with legit business models. A dry-cleaning outfit that had massive earnings per share results last year due to "income from investment activities" as opposed to "income from operations" is not doing so well now, as you can see. I do own a few others and update my portfolio regularly at EverydayFinance, but I don't recommend jumping in now on speculative Chinese stocks thinking you're buying on a dip. There could very well be another 30% down to go.

[chinesepetti]

Simply; do not even go near to the Chinese bubble ! invest every your penny in the iconic citi Bank, Mr Chuck Prince is calling you Mr Babak! Do you want his cell number?

[Asstmgrsc]

Articles like this can be useful to alert investors of possible problems, but they completely miss the mark for good journalism in that they do not even consider the justification for a markets rise. Question: have Chinese companies earnings increased 15% to 25% a year for the last six years? Does this earning increse justify higher stock prices; if so, how much? I don't know the answers to all of these questions, but before I write an article, presumably for pay, I would make some attempt to at least address the valuation question before just blasting away.

[Nepzone]

Many Chinese public listed companies are interlinked in their investments thru cross holdings and in the past many companies derived substantial profits from these shares. As such, as equity prices have decreased sharply, in the near future, a lot of companies will also report lower profits. It is a vicious circle!

[Nepzone]

Many Chinese public listed companies are interlinked in their investments thru cross holdings and in the past many companies derived substantial profits from these shares.

As such, as equity prices have decreased sharply, in the near future, a lot of companies will also report lower profits. It is a vicious circle!

[J.D]

The real bear market is going to turn into a vicious cycle, with SOEs earnings depressed from crossholding share losses, and accounting and governing weaknesses then coming to the fore. For the long term, a healthy process. For the near future, trouble.

[directore]

I don't get this praise for Cabot China & Emerging Markets Report. Read Goodwin's in October 07, the peak of China bubble - www.wallstreetreporter.... Two recommendations of his (extremely positive on both of them) JS and MR lost roughly 50% since then. You call it performance?

[danlin]

FXI is now trading at PE 14.86, why do you have to wait for A shares to drop another 50% to get a PE ratio 13.5?