China's stocks enter bear market territory on inflation fears

05/11/2010 11:26 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Meanwhile back in China…

The Shanghai Composite Index fell another 1.9% on May 11 putting Chinese stocks in bear market territory. The index is now down 21% from its November 23 high. The index is now down 19% for 2010 making it the worst performing market in the world—next to Greece.

The catalyst was news that consumer prices rose at the fastest rate in 18 months and that property prices in 70 cities rose by a 12.8% in April.

Inflation and speculation have so far not just resisted government policy designed to slow the rise in prices, but they’re actually accelerating. That has raised fears that the People’s Bank of China will finally have to raise its benchmark interest rate and put the brakes on growth across the entire economy.

Consumer prices—good old’ inflation—climbed 2.8% in April from a year earlier. That was up from the 2.4% rate of increase in March. The increase in consumer prices in March had been below February’s rate of increase raising hopes that the central bank was winning its battle against inflation. A survey of 30 economists by Bloomberg News showed a median expectation for a 2.7% gain in April consumer prices.

The real bad news is actually in the bad news behind these numbers.

The People’s Bank and government bank regulators have tried every trick in their books—short of an actual increase in the benchmark interest rate—to rein in bank lending. It’s easy money from bank loans that has fueled the real estate boom and the binge of investment in fixed assets that has kept the economy running too hot. (Growth hit 11.9% in the first quarter of 2010.) The surge in bank loans in 2009 has raised fears, extremely well founded in my opinion, that many of these loans are to unqualified but well connected individuals or companies and that they will result in a dangerous increase in bad loans on bank balance sheets.

The bad news—nothing the central banks or regulators have done is slowing the flood of loan money to a rate that economists think is acceptable. New lending in April of 774 renminbi—or about $110 billion—was above the consensus forecasts of 24 economists surveyed by Bloomberg News.

At 2.8% inflation is getting very close to the government’s target of a 3% inflation rate for the entire year. I doubt that the People’s Bank or bank regulators will sit on their hands until inflation reaches that benchmark.

Falling stock prices in Shanghai indicate that investors there are expecting action too.

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