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No madness in market's methods

By Hong Liang (China Daily)
Updated: 2008-09-09 07:51

Despite the violent swings in the lead indicators, the Chinese stock market is anything but a giant casino as many frustrated commentators and despondent investors would love to have you believe largely because they felt embarrassed to have missed all those tell-tale economic signs.

In fact, the market has behaved quite predictably in the past few years, always keeping in lockstep with the economic trend.

Some economists hold the view that the maddening bull run that kept the market on the boil through most of 2007 was kicked off sometime in late 2006 by the share reform, which was supposed to have lifted the overhanging cloud of the so-called "non-tradable" scripts. That was also the time when economic growth was rapidly gaining momentum.

The export boom had flooded the domestic economy with liquidity. Cheap and easy credit helped fuel an investment bonanza in the development of infrastructure, plant and machinery and, of course, real estate. Property prices in some major cities, particularly Shanghai and Shenzhen, had nearly doubled in 12 months.

The red-hot economy, combined with low funding costs, gave a big boost to the profitability of the corporate sector. High expectations of the performances of many listed companies had fired investors' enthusiasm and stoked the stock market rally which sucked in larger and larger amounts of new funds siphoned off from low-yielding bank deposits.

Liquidity in the stock market was further swelled by a continuous inflow of "hot money" enticed by the expectation of the appreciation of the renminbi against the US dollar and most other major currencies.

All told, there was really nothing mysterious or unique about the great China stock market rally of 2007. If you had been following the course of the rally, you would not have been surprised by the crash of 2008, which was no more than a consequence of changing economic fundamentals that surfaced months before the index took the dive.

Anyone who had witnessed first- hand the boom and bust cycle of the Hong Kong equities in the early 1970s would understand that major market shifts don't happen by chance, and market makers are not happy-go-lucky gamblers.

To be sure, the relative lack of market transparency and shortcomings in regulatory enforcement efforts have heightened the risk factor in investing in Chinese equities. But the many conspiracy theories that were put forward by the self-styled investment gurus in their blogs and columns seemed decidedly fictional.

They were the same people goading investors to hop on to the stock market gravy train when the economy was flashing the red warning sign of escalating inflation as early as in mid-2006. The surge in pork and egg prices may not have much of a direct impact on stock investment. But some economists began to warn that the rise in international commodity prices, including oil, coal and a wide range of metal and grain, could seriously push up production costs and cut into the profits of China's manufacturing enterprises.

The outbreak of the US subprime credit crisis that threatened to drag the global economy into a slow-down dealt another blow to investors' confidence by casting a dark shadow over the prospect of China's export trade. The monetary tightening measures introduced to combat inflation certainly didn't help.

The disappointing interim figures of China's corporate sector have largely confirmed earlier worries about a profit squeeze. Although the benchmark index has already tumbled more than 50 percent from its peak in October 2007, the market is still going through a massive revaluation process to adjust for the projected slowdown in earnings growth in 2008 and beyond.

This is economic reality. The stock market is for risk takers, not gamblers.

E-mail: jamesleung@chinadaily.com.cn

(China Daily 09/09/2008 page8)