Friday, March 2, 2007

Understanding the Market: Why? Whether? When?

Given that China's stock market has been more than doubled in the past year and the Shanghai and Shenzhen 300 Index, which covers 300 major listed companies, is now valued at 38 times earnings, something like week's tumble, a 9.2\% plunge in one day, is just predictable. The real valid question is: Why Tuesday?

Please be reminded that Tuesday was the 2nd trading day after the Chinese New Year and the annual session of National People's Congress is due to open this Saturday. During the two-week gathering, budget and legislative proposals will be read and economic and social issues will be discussed by the more than two thousand delegates. The stock market, which has been drawing everybody's attention recently and has generated some biggest concerns, will definitely be among the top issues. Hence, after a modest rise on Monday, Tuesday became an ideal time for mood changing: happy time is over and uncertainty is on the way. It's just common sense that there is no way to continue last year's skyrocketing momentum when there is no huge fundamental improvement. And when you see tons of people are rushing to the market with their newly-borrowed money, you know something is going to happen: ``negative feedback'' is about to kick in. And your action? To sell.

It's interesting to see that many reports postulated that China's selloff in stocks ``triggered'' the domino-like spread globally, leaving the Dow Jones Industrial Average posted the most significant fall in more than five years at the other end of the Pacific. The natural question here is: Whether this is true?

In the many-dimension business world, it's almost always impossible to prove something is right in strict sense. But we can adopt a humble strategy: it's usually much easier to show it's wrong, or at least, not that convincing. Suppose the assumption that such a China effect is strong enough, then we can conclude that it's those countries that have the closest trade and financial connections with China that would be hurt the most; and in all countries, it's those similar type industries/companies that would be the major victims. But to my best knowledge, the distribution is quite even. I am not saying the postulation is wrong: the effect is just not that significant.

Now comes the fundamental question: Is this a long-awaited correction or does it suggest an end to the bull market? In other words, When the market will change?

In a probabilistic sense, my take is the former. Inflation rate is still low, hence the People's Bank of China, which has adopted inflation targeting, has no intension to increase the interest rate. And to not to accelerate the Renminbi appreciation process, PBoC has even less desire to do so very soon. Hence the liquidity is still out there and you can expect asset prices may still be high for a while. When will change come? When the above fundamentals change or something, which is really unexpected and significant enough happen.

P.S. With regard to the Renminbi appreciation issue, I just can't be philosophically convinced that a discrete manner is needed in a continuous world: market will do the gradual adjustment trick by itself. (In reality, the daily fluctuation band against the US dollar, $ $ 0.3\%, has rarely, if ever, been reached.)