Where is the Bottom?

So mainland shares have started falling- finally- in the wake of the tripling of stamp duties. Just how far will they fall, and does this represent the end of the bubble market?

These questions are impossible to answer definitively. First, day-to-day market performance depends crucially on sentiment and expectations. I will not even pretend to be equiped to make a prediction on how these will play out in the coming days. However, I am encouraged that for a second consecuative day a number of major equities have fallen by the maximum allowable 10% daily decline. (Update: they've bounced back....)

Second, just as it's impossible to be certain that the market represented a bubble (rather than the rational expectations of investors) in the first place, so it is impossible to be sure that the market has in fact returned to fundamental levels.

But in the case of China, there are some indicators that we can look at. First, A-shares listed in Shanghai were trading at an average premium of about 200% over H-shares of the same companies listed in Hong Kong. Even though capital controls effectively segment the market (mainland Chinese cannot invest in Hong Kong equities), this difference is far higher than can be justified by fundamentals. Even without a bubble, some difference in price will remain: the fundamental price of equities depends on the opportunity cost of not investing in the next best alternative instrument. Hong Kong's openness and capital mobility provide a vast array of possible investment products, potentially decreasing the value investors place on holding shares in mainland companies relative to their mainland counterparts. Without being very precise about it, I'd guess that this could account for about a 20% - 50% premium... far less than the original 200%.

And second, we need to stop seeing stories like these ones

"About 10 percent of maids in Shanghai resigned because they made more money trading shares......"

"Investors on May 28 opened 455,111 accounts, a daily record. "

My best guess: we need a few more days of the major shares declining their maximum 10% before we can say with any confidence that the bubble has been deflated. Ideally this will also leave investors with a more informed view of the risks they take when they hold equities, driving out unrealistic expectations of market gains at the same time.