By Hong Liang (China Daily)
Updated: 2008-01-29 10:58

Global stock markets had a pretty rough time last week, and China was no exception.

The factors that drove down world stock prices are well known. Of primary concern to investors must have been deepening worries about a possible US recession that could drag the global economy along with it. In this respect, China should be an exception.

Of course, many economists have predicted a slow down in GDP growth in 2008 compared to the double-digit increases in the past two years. A slow down to perhaps 7 or 8 percent may seem a little more abrupt than economists had earlier expected. But many economists would also agree that the exceptionally high growth rates in 2006 and 2007 were unsustainable because they were a reflection of economic overheating.

The question hanging over the Chinese stock market now is how do investors interpret the key economic indicators, including inflation, bank credit and exports. It is common knowledge that the spectacular stock market rally of 2007 was largely driven by liquidity, or, more precisely, the massive transfer of capital from bank saving deposits to the stock market. In this investment environment, investors' collective sentiment is usually the major driving force behind price swings.

When the stock market was on the boil in last August, many analysts had warned about the bubble effect as indicated by an excessively high average market multiples of over 60 times, compared to less than 20 in other regional markets. But market overvaluation seemed too abstract a notion to make an impression on the many investors. Their stampede to buy shares subsequently pushed the index up several notches before the fear of government action to cool the stock fever began to sink in around November.

The market then was poised for a major correction. But the market bull had demonstrated its amazing resilience by staging a rebound almost immediately after every price dip. It would have to take a worldwide market slump to prompt a serious price adjustment in the domestic market.

Although the sell-off last week seemed brutal with the index losing a total of 12 percent in the first two days of trading, the average price to earnings ratio has remained in the high 50s. What is more, analysts have reported no sign of a selling stampede by individual investors. The major sellers have been institutional investors simply because there is no other means, such as index futures, to lock in their gains in these uncertain times.

Of course, many individual investors have also been unloading parts of their holdings to realize earlier gains. But analysts say that investors' confidence in the longer-term future of the stock market has remained intact despite the shock.

From the perspective of an economic planner, prospects in the coming months look more encouraging than grim. Inflation, a primary concern, seems likely to ease because the sharp increase in the prices of food, particularly pork and eggs, is seen to be tapering off. Some economists have predicted that the rate of increase in the CPI index will fall to the acceptable 3 to 4 percent levels by the latter part of this year as supply and demand of various food products regain equilibrium.

On the foreign trade front, the expected slow down in US economic growth will no doubt dampen consumers' demand for imports, including those from China. Although the overall trade balance may not fall appreciably this year, the surplus is widely expected to have peaked. A flat export performance could lop a couple of percentage points off the GDP growth rate. But it is considered a healthy slow down by some economists, concerned about past economic overheating.