Sigh. I read this article on Bloomberg yesterday, and I was gonna let it slip, since it comments on how “spikes in turnover tends to precede market declines”. In other news, “Market tops precede market declines.” If I commented on every dumb article online then I seriously would have no time to analyze anything, so just let it go and hope it fades into obscurity… Then it’s the top headline when I open Bloomberg this morning, and that was the straw. Sigh…
Here’s why it’s dumb beyond comparison: Liquidity Risk Premium. Turnover is one type of proxy for market liquidity, and this means that when markets are broadly up on higher turnover, it tends to outrun valuations since market participants perceive less risk from the liquidity. It’s rather basic finance, easy to research through a single Google search, and it’s the primary early-stage driver of every “flight to safety” currency move that’s been reported on ever.
So of course the headline-inspiring analyst abuses this to state that “Chinese fundamentals don’t support current pricing”. Let’s retrace: the last time we crossed these turnover levels (on monthly averages) were in November 2010 “which led to a 46% drop on the Shanghai Composite”. First of all, the averages analysis you’re doing is dumb, since the fluctuations now means the peak has long-since left your averages behind. Second: The market bounced back almost from that 4-5 months later, nearly invalidating your analysis. Third: the bottom you’re speaking of occurred three and a half years later! Fourth: the euro zone got plunged into crisis which was concurrent with all of this. So, I can only presume that Bloomberg’s journalists conclude that Chinese turnovers caused the euro zone crisis! Seriously, aren’t you guys ashamed to put this at the top of your headlines? Sure, you might have a journalist or two who really hates China, but why on Earth your editors who oversaw this still have a job is completely beyond me. I wouldn’t dare update a Facebook status writing something so stupid…
Is China’s market overvalued? It could well be. But do I favour the Shanghai Composite now, when foreign investors can trade it and China will likely expand the program, and we’re seeing aggressive reform pushes the likes of which China hasn’t experienced since Deng Xiaoping? I think the case is rather strong, especially since we get continuing signs of liquidity support from the People’s Bank of China, and there is a big IPO pipeline still to work through. Also, in April 2011 (I refuse to consider the peak they’re talking about as significant, I’m restraining myself not to insult Bloomberg any more than necessary) the index value was at more than 30% above today’s pricing! Again, the index might go down, we’ll never know, but we’ll know all the less if we insist on making idiotic inferences from cherry-picked data to suit our thesis.
Let me pick apart the analysis, step by step.
“Valuations have been sent to a 20-month high!” So… look at those damn 20 months then, and then come back. Xi Jinping is running the show, rather successfully it appears. The boot has been taken off the interest rate breaks, and China now looks at a property market that isn’t surging consistently on a month-to-month basis. Part of the reason that valuations had to be a bit depressed during that time was that Xi Jinping’s anti-corruption “mass line” program demanded excesses to be wrought out of the system as well. Are Chinese valuations unsustainable? Probably not, they’re still trading at a discount to Hong Kong, and Asian markets generally are not that highly valued in P/E or /B terms. Thus… a Bank of America analyst is bickering about higher valuations now? Did I misinterpret this article as anything but comedy?
“Corporate debt levels are rising and there is excess capacity in some industries.” Bank lending to corporates is indeed high, but overall financing, equity financing in particular, is comparatively low. There is much better prospects for capital market openings that will allow banks to go to corporate bond route of debt like the US. Also… if IPOs are restricted for a year or two, and companies need financing to meet continued high growth in China, what where you expecting? That they conjure financing from thin damn air? This type of analysis gets you to the top of Institutional Investor Magazine? Say it ain’t so… Excess capacity in some industries sounds like even you know how wishy-washy that sounds and I guess that’s why there is no data provided to back the point up, because that could literally mean that “all but one” industry is either having overcapacity or “all but two” industries are facing capacity shortages. Yes, the data recently hasn’t been too good but you don’t even address this!
“Loosening will release liquidity into the property market and speculative activities.” I have consistently argued for more liquidity in China, because the very reason these speculative activities are popular is because there are too few alternatives to invest in openly, officially and through decent channels given the amount of available investment capital. Restricting the investable asset space further will not help this, and thus increasing the investable asset space will make capital less concentrated, better diversified and hopefully allow decent hedging. In the mean time, while these processes are ongoing, we need liquidity to support the formation and capital flows into these new investment classes. That’s my personal investment thesis in China, has been for a long time, and the opening of the Shanghai – Hong Kong Stock Connect and IPOs opening again illustrates this very well as first steps. The liquidity itself finding its way into the housing market and speculative activities is probably not going to be a positive for growth, but you know what? You need liquidity to power SME lending, enormous shifts towards funds that soak up savings and provides social security so the overall savings levels can go down and allow consumption to increase, which would accelerate the domestic velocity of money, and for allowing companies to go into non-debt financing for CapEx since their earnings will likely increase and there is a much more accommodating equity market to sell shares into. Of course, compared to bank deposits (which is where all the assets that constitute this liquidity come from originally) anything is a “speculative activity”. I’m at a loss for words to even describe how little I think of analysis like this, so if anyone can provide the data this guy bases his assumptions on, I would really appreciate it. I’m not gonna look into it further myself, since… well honestly I have better things to do with my time than trying to disprove that people are uninformed and the risk of finding more proof of that isn’t too appealing to me.
When short-term technical analysis (with several flaws even by TA standards) is your best argument for a specific, long-term fundamental market expectation on an index largely driven by political decisions is the best thing in favour of your analysis of the future of said index, you know you’ve just thrown yourself under the bus, right?