Potential China bubble

Discussion in 'Trading' started by Cutten, May 10, 2007.

  1. Following the action in the Chinese stockmarket, I've noticed some similarities with previous runups during the later stages of a big boom/bubble - a good comparison is the Nasdaq in late 1999/early 2000. I'm therefore beginning to plan for a potential bubble top and subsequent crash in that market.

    There are certain preconditions that almost all bubbles/crashes share in common:

    1) Prices must have undergone an extraordinary advance over the previous years.

    2) Valuations must be extremely stretched.

    3) Sentiment amongst speculators and the public must become extremely short-term and bullish, with little heed paid to risk or the possibility of a major decline.

    4) Volume should be exceptionally high, relative to the typical historical norms in that market.

    5) Volatility increases substantially as the market experiences a parabolic runup in the last few months of the bubble. Sharp and vicious corrections occur, convincing people the rally has ended, only for the market to swiftly turn round and run higher again. This doesn't *always* happen, but it is extremely common.

    If we look at prior bubbles such as Nikkei 1989-1990, Nasdaq 1999-2000, Gulf Markets 2005-2006, US stocks 1987, Oil/commodities 1979-1980, we see that all these preconditions were fulfilled. Each market eventually topped and experienced a severe decline - either a short but significant crash, or a sustained bear market of 1-2 years (or more in some cases).

    In the case of China, it rose from seriously undervalued levels (when it was around 1000), and has good long-term growth prospects, so I would not expect a secular bear market. I think it is more likely to follow a kind of S&P 1998 or 1987 scenario - a correction ending with a vicious collapse.

    Looking at the Chinese stock market now (taking the Shangai composite as the lead index), I see most of the preconditions in place.

    1) Price runup: the market soared in the last couple of years, going from just under 1000 to 4000.

    2) Valuations: the historical PE is now 42, according to Bloomberg.

    3) Sentiment: domestic sentiment is strongly bullish and becoming increasingly speculative. Record numbers of Chinese are opening brokerage accounts and starting to trade the market. I do however think that sentiment is not quite as bullish as during normal bubble tops - not yet anyway.

    4) Volume: turnover on the Chinese markets is at record levels, now almost as much as all the other Asian markets put together.

    5) Volatility: the market has become more volatile recently. The correction in Feb/March has followed the classic pattern of sharp selloff causing a spike in bearish sentiment, then rebounding strongly and going to new highs, confounding the people who sold out in a panic. This is very similar to the pattern in the Nasdaq in 2000.

    So, I think the preconditions are there for a top and substantial fall at some point. Certainly there is enough to start considering when to pick the top in this market.

    In my next post I'll focus on the more difficult part - how to time it.
     
  2. Thanks for your thoughts Cutten...interesting stuff. How do you feel about the idea that "the government won't let the market falls before the olympics" theorists? It makes sense to me and I think their markets are illiquid enough for the government to happily prop it up.
     
  3. john12

    john12

    what do you mean you're preparing for a crash? a crash of china or a crash of all markets?how are you preparing for a crash?
     
  4. Chinese Govt has 1.2 trillion USD to support their market. Do you think they will let it crash?
     
  5. Did you read the Title of the post and the content? :D
     
  6. I don' know. . .a "potential" China bubble? I think the quoted word can safely be removed to be more precise. :p