林中斌 部落格 / Blog Chong-Pin Lin

Figures indicate decline, though not unprecedented

NEIL IRWIN, The New York Times, JULY 8, 2015

http://www.nytimes.com/2015/07/07/upshot/how-to-make-sense-of-chinas-plummeting-stock-market.html?abt=0002&abg=1  accessed July 20, 2015

紐約時報說中國股災雖然痛苦，但並非史無前例，2007-2008年時情形更嚴重。

林中斌 2015.7.20

 While the eyes of the world have been on the crisis in Greece, China, a country with 123 times its population, has faced financial troubles of its own. A free fall in the Chinese stock market could threaten the prosperity of the world’s second-largest economy and have long-term effects of its own.

But the numbers suggest that the stock market collapse — it’s down 32 percent in four weeks — may be less a shocking turn of events and more an inevitable correction in a market that featured many of the classic signs of a financial bubble.

Stock investing has become a middle-class pastime in China in recent years, and it’s clear the Chinese government is nervous that a continued market rout will wipe out its citizens’ wealth and stoke discord. The Chinese government has pulled out a series of policy measures to try to avert the collapse: interest rate cuts; using government pension funds to prop up the market; announcing plans to investigate those betting on a market drop.

The data, though, suggest that the market declines thus far aren’t as outlandish as the Chinese government seems to think. The Shanghai composite index began an upward tear in late 2014, soaring 151 percent from the start of July last year to the June 12 high.

The chart shows how easy it is to frame market data in a way that sounds either scary or benign, depending on your inclination. “The Chinese stock market has dropped 32 percent in a month” is scary. “The Chinese stock market is up 70 percent over the last year” sounds great. Both are true.

In that sense, the people who have lost money in the last month are those who plowed money into Chinese stocks just in the last few months, aiming to take part in what seemed a rocket trajectory rise in prices. Anyone who has been invested for more than a few months is doing just fine, so far at least.

As it turns out, if you look at a slightly longer time horizon, the kind of volatility in Chinese stocks witnessed over the last year isn’t that uncommon. The 2010 to 2013 period was more aberration than trend in the steady, consistent rise in prices.

Consider the Shanghai composite over the last decade, indexed to its June 2005 level and compared to an index of all global stocks. The Chinese market experienced much larger swings during its 2007 boom, 2008 bust and 2009-2010 resurgence than the rest of the world. And those swings were larger in percentage terms than the recent volatility. Big swings in the Chinese stock market may be damaging for Chinese savers, but they don’t necessarily ripple across the global economy the way problems in United States mortgage securities did in 2008 or European debt did in 2011.

Why so much volatility? The Chinese stock market is less well developed than those in countries with more advanced financial markets. Many of the strongest Chinese companies list their shares in Hong Kong or New York, with those listing within China more likely to have questionable business models, accounting and corporate governance.

That has helped fuel wild swings between great optimism and great pessimism for Chinese stocks. That is no salve for the pain of individual investors who have lost their savings in the recent market drop, but it does support the idea that they had reason to know the kind of risk they were taking on.

But what about fundamentals? Are Chinese stocks falling toward a fair price relative to their earnings and growth rates or overshooting with further to fall 

Just a year ago, Chinese stocks looked relatively reasonably priced, with a price-to-earnings ratio of around 10, meaning an investor paid the equivalent of about $10 for a share of stock that offered $1 per share in annual earnings. By contrast, at the same time last summer, an investor in American stocks had to pay more like $17 for a share that produced $1 in income. 

But the sharp rise in Chinese share prices starting in late 2014 took place without an accompanying rise in earnings. The shares rose because investors were willing to pay more for the same return.

By early June, the price-earnings ratio of the Shanghai composite index had soared to nearly 26, meaning the same dollar in earnings that cost $10 a year ago now cost an investor in those stocks $26. The swoon in prices since then has left that ratio at 18, still a bit pricier than the American market, but still quite a bit higher than the valuation of the Chinese market just a year ago. 

There is a case that Chinese stocks deserve a rich valuation. If you expect that the companies whose shares you are buying will become much more profitable over time — that is, that they will grow quickly — it might make perfect sense to pay $18 or $26 for a dollar of earnings. That dollar, after all, might soon be two, and then four.

But it’s worth looking at the economic backdrop as those companies will be trying to increase their earnings. 

The Chinese economy was growing by 10 to 12 percent a decade ago, an environment conducive to rapid growth in corporate profits. That has been falling steadily, to 7 percent in the most recent reading. China has been trying to adjust to a more consumer-driven economy, away from housing, infrastructure and imports, but it has been a rocky process. 

In other words, valuations are higher relative to earnings, even as economic growth prospects have slowed. And it’s hard to see anything in Chinese economic conditions or policies that changed between July 2014 and June 2015 that would justify the kind of remarkable increase that preceded the recent crash.

Put all these pieces together, and here’s what we have: a rise in Chinese share prices in the last year that seemed to be driven more by investor psychology than by anything fundamental. It is hard to see how the prices as of a month ago were justified, and easy to see why the sell-off of the last month would occur. 

That, in turn, implies that Chinese officials are fighting an uphill battle in their policy moves to try to stop the correction, and helps explain why their policy actions have had little effect so far.

The question now for China — and hence for the world economy — is how far the Chinese market has to fall, and, regardless of whether the drop is justified, how much pain it will cause.