Tuesday, August 28, 2007

China "A" shares bubble

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Just thinking out loud. In February 2007, a 7% one day drop in China A shares (who trade in their own twilight zone) precipitated a worldwide market correction for 3 weeks....

With the equivalent of the US Fed in China raising interest rates multiple times this year, now >7%....
With the reduction of demand for A shares, in the form of opening new markets (Hong Kong) to individual investors....
With the growing backlash against China products due to safety issues....
Will that dent demand in the near term? Increase costs?
What about the price inflation in food in China?

What does it mean? What would a 20% reduction in 3 weeks in the China A shares mean for world markets? If a 7% 1 day drop caused some serious issues back in late winter. And layer that onto the current environment - how would people react emotionally?

I think the China A shares are due for a fall, they are exhibiting bubble like behavior and have been so for a long time. Having lived through NASDAQ 99-01, it sounds very similar - with the same news stories you read back then - housewives daytrading, investments being pulled out of savings and into the market, "how easy it all is", investment gurus sprouting up on the internet in China, etc. The case for China (India) remains strong for the next 10+ years, but the next 12-24 months? Hmmm.... everyone says there will be no issues with China until at least the summer Olympics in 2008. When everyone says something, that makes me nervous. Consensus and group think... wasn't that what got the quant hedge funds in trouble?

Now some people were calling for the fall of the NASDAQ by late 99, and the market just continued upward for nearly 16 more months thereafter so making a call and being right intellectually doesn't mean much if you waste all your capital (as many shorts did in those times). They were right eventually but most did not have cash to take advantage of the dramatic drop.

Again, this is a huge secular play - this coming out party for 3/5 of the world's population (China/India) but that does not mean there will not be dramatic drops during a long term uptrend. 40-60% annualized gains in emerging market mutual funds year after year just don't happen, but some people seem to be expecting it. Hence I am extremely cautious on this group. Without an instrument to directly short the A shares you can only sit and expound, but I think as important as the drop in that market (when it does eventually happen) will be the hand wringing of 'what does it mean?' - while I think its relatively benign other than a confidence killer, economically - once human emotion is involved, things can take on a life of their own so that will be the main worry.

For those who enjoy super beta and like risk.... one play might be some put buying on the FXI mentioned yesterday iShares Xinhau China 25 - just for reference with the ETF trading @ $145, a contract such as January 140s trades at 13.10/13.60 (FAHMH) - again these have surged based on the opening of floodgates to Hong Kong, but if there is any serious correction in the A shares, they would go down as well. FXI has gone from 120 to 155 in about a week (nearly 30%)... let's watch it.

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