A New Chinese Stock Exchange?

The long list of stock exchanges in the U.S. is slowly being whittled down to a few. With the NASDAQ and NYSE slowly acquiring smaller stock exchanges, the trend seems to be heading towards larger and fewer stock exchanges.

So whats happening in China? Bucking the trend, Shenzhen is starting a new stock exchange for small and medium sized start-ups. The timing seems even stranger when one considers the 21.2% YTD drop the Shanghai Composite Index has undergone and the possible decline in growth the whole world might be heading into.

So what does exactly does this bring to China? As a stock exchange focused on start-ups, it would be encouraging entrepreneurship and creativity, making it a lot easier to get funding. The strange timing might even be a blessing in disguise. The huge potential of start-ups come with a very large downside, much more than the blue-caps at the Shanghai Stock Exchange. Fears of a slowdown in Chinese growth may prevent over-exuberant valuations and help protect investors.

At this point of time, manufacturing still accounts for approximately 50% of China’s GDP. In order to make a step up, China needs to move towards a knowledge-based economy, coming up with the ideas rather than manufacturing the ideas of others. Increasing access and improving the ease of obtaining funds will only expedite this process, advancing China’s growth potential.

The Chinese Stock Bubble

A little article I wrote for the trading floor newsletter at the beginning of the year. With the Shanghai Composite Index already down 12%, it doesn’t seem such a bad analysis after all…

The Chinese Stock Bubble

Three decades of solid double-digit growth in GDP has made China the third largest economy in the world. Yet despite the shape of the economy, it wasn’t until 2006 till the Chinese stock markets became recognized on the world stage. The Shanghai Composite Index averaged a 113.6% annual return over the last two years to make it the fifth largest stock exchange in the world by market capitalization. Such returns seem neither sustainable or realistic indefinitely, and this explosion has the earmarks of a market bubble.

After five consecutive years of negative growth in the stock market, the Chinese government lifted a ban on IPOs in the middle of 2006, and relaxed restrictions to encourage many of the largest Chinese companies who previously were only listed on the Hong Kong or/and American Stock Exchanges to start raising funds in mainland China. These new entrants may have brought in repute into the markets of a country where corruption is rife. Perhaps this is what triggered what Alan Greenspan termed as “irrational exuberance”. No market bubble has occurred without investors speculating and driving up prices beyond rational expectations of its real worth. China’s new found wealth meant a burgeoning middle class who had no place to put their savings. Constricted to just investments in mainland China, the stock market now seemed the best and safest place to put your savings, and everybody was doing it. There was also a commonly-held belief that the government, who holds majority holdings in many benchmark companies, would not let the markets crash before the Beijing Olympics due to the devastating effect it might have on its economy and reputation.

Not many countries have had a major index quadrupled in two years. Yet with the Shanghai Composite and Shenzhen Composite having P/E ratios of 65 and 72 times trailing earnings respectively, the markets are undoubtedly due a market correction, a fact not missed by the government. Chinese government has a lot more control and has been trying its best to control the euphoria in the stock market, even going as far as to warn investors that a bubble might be forming and to be increasingly cautious. The markets themselves have a few measures in place that might help mitigate the effects of a correction. The two Chinese stock exchanges have implemented caps which prevent stocks from rising or falling more than 10% a day by halting any trading on that stock. Short-selling is also illegal in China due to a suspicion that it might exacerbate market crashes. And of course the classic move of increasing interest rates hasn’t been neglected with interest rates raised six times in 2007 to a nine-year high of 7.47 percent. Yet despite all their efforts, the markets have continued to grow unabated, market forces prevailing in spite of the government’s actions. It certainly seems inevitable that the Chinese markets will crash; the only question left unanswered is when it will occur, and how bad it will be.