China’s Stock Bubble Will End in Tears

05/09/2007 12:00 am EST

Focus:

Nicholas Vardy

Editor, Bull Market Alert, The Alpha Investor Letter, and The Global Guru

Nicholas Vardy, editor of the Global Guru, says the euphoria in the Chinese market fits the pattern of a classic mania and like all manias it will end badly.

Even the biggest China bulls around admit that China is in a bubble. The Shanghai Composite index is now approaching 4,000-a rise of nearly 50% so far this year after a 130% increase in 2006. The Shanghai and Shenzhen exchanges now have a market capitalization of about 15 trillion yuan ($1.8 trillion). While that doesn't make it a big market globally-the New York Stock Exchange had a total capitalization of $26.5 trillion as of Dec. 31-China's market places second in Asia, behind Japan, after surpassing Hong Kong just last month.

Anecdotal accounts of China's current mania are distressingly familiar. Investors are queuing to open accounts at local securities houses, as applications are five times as high as a year ago. There are now more than 91 million accounts held by individuals at brokerages or in mutual funds. About 10% of these accounts were opened in just the first three months of this year-and ten times as many accounts were opened in the first quarter of 2006 as for all of 2005.

Students and pensioners crowd around computer terminals watching ticker signs go by. One out of three university students in China is playing the markets. New technology-Internet and mobile telephony-has only exacerbated the mania. Online trading is spreading rapidly, and many employees spend their workday trading through E-mails and instant messaging. China's stock market newbies have started pawning personal assets to invest in shares.

Today, the Shanghai market may have already peaked. The bottom has already dropped out of the markets twice this year-on February 27 and April 19-on the back of rumors of a government crackdown. China's leaders are worried, but essentially helpless. Local players have ignored interest-rate rises and increases in banks' reserve requirements. And there's little the government can do to control the Chinese obsession with gambling. It's no surprise that the same year that [the Shanghai index] more than doubled, the casinos in Macao recorded higher revenues than the Las Vegas Strip.

The China stock mania will end in tears-as has every other stock market mania in history. Indeed, place the long-term charts of the Shanghai index alongside the NASDAQ [during the Internet bubble], and the patterns are eerily similar. The Chinese authorities will try to intervene-unsuccessfully. And when the bubble pops, the negative effects will be profound. If tens of millions of urban Chinese lose their shirts, they'll be looking to the government to bail them out-or else, they will turn very angry. Not even Chinese mandarins have power over the laws of financial speculation.

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