I've talked repeatedly here about China's equities bubble (for my last installment, see here). But here's another piece of the puzzle. Bloomberg reported on November 5 that on its first day of trading in Shanghai, Petro China tripled in value, and became the most valuable company in the world by market cap- much larger than any other oil company, even though several of these have significantly higher revenues, oil reserves, and other assets.
Or consider this table published in mid-October. Of the 25 most valuable companies in the world by market cap, 8 were Chinese, while only one Japanese company, Toyota, makes the list- even though Japan is the world's second largest national economy, and many Japanese companies are global brands, with a strong global presence.
Focusing on financial institutions on the same list, there are 4 Chinese companies on the list, and only three from the rest of the world.
Yes, China represents a great opportunity for future growth and therefore future profits. But this great?
Showing posts with label Bubbles. Show all posts
Showing posts with label Bubbles. Show all posts
Wednesday, November 21, 2007
Monday, November 19, 2007
Do you buy or sell an appreciating asset?
This must be "undercover economist" day at HongKongMacro. Here's another facinating post by Tim Harford.
The crux of the post: should you buy an asset that has appreciated in price, or not? Clearly if you failed to buy it when it was cheaper before, and you were rational about your decision then, you should be less likely to buy the asset now. But many financial analysts seem to have different ideas. The fact the price has gone up must mean that it's an asset worth holding.... or something like that.
I shouldn't complain. Markets would be far less interesting if we all invested like economists. There would be no bubbles, and we'd have a lot less to talk about! Just look at the Hang Seng Index, which has dropped almost 15% since October 30.
The crux of the post: should you buy an asset that has appreciated in price, or not? Clearly if you failed to buy it when it was cheaper before, and you were rational about your decision then, you should be less likely to buy the asset now. But many financial analysts seem to have different ideas. The fact the price has gone up must mean that it's an asset worth holding.... or something like that.
I shouldn't complain. Markets would be far less interesting if we all invested like economists. There would be no bubbles, and we'd have a lot less to talk about! Just look at the Hang Seng Index, which has dropped almost 15% since October 30.
Wednesday, November 14, 2007
Mainland Futures...
There's a new feature that may be introduced shortly that may have a profound effect on mainland equities. I've argued before that Mainland Chinese equities represent a bubble, and that one day it must burst. One reason why it's lasted so long is that there are no instruments available for investors in the mainland to short equities. Thus people who think that the market is overvalued remove their money from the market, but can do little more. Investors who remain are by definition optimists, who believe that the market will continue to rise- otherwise they wouldn't invest in the first place!
In an economy where the number of new investors is growing at incredible rates (remember those reports about hundreds of thousands of new equity accounts being opened every day?), there's no stortage of optimism.
But now that pie cart may be about to be overturned. From today's South China Morning Post:
"The imminent launch of index futures in the mainland is increasingly spooking investors who fear it could herald a sharp correction in a market that has almost doubled this year."
The response?
"The mainland's stock benchmarks slipped for a fourth day yesterday as investors braced for the introduction of a system that will allow big funds to bet on a market decline. The losses contrasted with a rebound in the Hong Kong market."
So mainland investors may be able to short mainland equities soon, and that's enough for the market to drop? Chalk that up to additional evidence of a bubble...
In an economy where the number of new investors is growing at incredible rates (remember those reports about hundreds of thousands of new equity accounts being opened every day?), there's no stortage of optimism.
But now that pie cart may be about to be overturned. From today's South China Morning Post:
"The imminent launch of index futures in the mainland is increasingly spooking investors who fear it could herald a sharp correction in a market that has almost doubled this year."
The response?
"The mainland's stock benchmarks slipped for a fourth day yesterday as investors braced for the introduction of a system that will allow big funds to bet on a market decline. The losses contrasted with a rebound in the Hong Kong market."
So mainland investors may be able to short mainland equities soon, and that's enough for the market to drop? Chalk that up to additional evidence of a bubble...
Monday, October 29, 2007
Froth and Bubbles....
"What should China do to try to reduce excess liquidity and inflation" - Qin
China is increasingly exhibiting the signs of an overheating economy. Asset prices are incredible (literally, in my view; see here for my earlier views), and domestic price inflation has increased to 6.5%, with increasing signs of further rises to come.
What can China do about this? Let's start with the standard prescriptions: a contractionary policy, using either fiscal or monetary policy. On the fiscal side, this could take the form of either a tax rise or a government spending cut. Given the chronic state of many parts of the mainland government sector (for example, health care), a spending cut seems out of the question. Further, a significant tax rise is likely to result in increasing compliance issues, so may not be desirable either.
That leaves us with monetary policy, which has already been tried with limited effect. In part that is because any increase in interest rates is being offset by an increasing money supply due to growing foreign reserves. When Beijing prevents the RMB from appreciating by buying USD assets, it increases the money supply by an offsetting amount. The scale of this is almost impossible to sterilize, so the net effect is actually an expansionary monetary policy, in contrast to the contractionary one that is required to stabilize the economy.
My conclusion is that ultimately, stabilizing the economy in China will require the rate of money supply growth to fall. A significant appreciation of the currency would certainly help, as this would reduce the growth rate of foreign reserves, and the corresponding injection of currency into the economy. An alternative would be to encourage increased capital outflows, so that the current rate of appreciation of the currency could be maintained with less official intervention.
Based on the rapid appreciation of the RMB earlier today, maybe the mainland authorities are opting for more rapid currency appreciation, although one day is hardly a trend! In sum, any action by Beijing to try to slow the money supply brings with it significant economic risks. But doing nothing and hoping for the best may bring even greater risks.
China is increasingly exhibiting the signs of an overheating economy. Asset prices are incredible (literally, in my view; see here for my earlier views), and domestic price inflation has increased to 6.5%, with increasing signs of further rises to come.
What can China do about this? Let's start with the standard prescriptions: a contractionary policy, using either fiscal or monetary policy. On the fiscal side, this could take the form of either a tax rise or a government spending cut. Given the chronic state of many parts of the mainland government sector (for example, health care), a spending cut seems out of the question. Further, a significant tax rise is likely to result in increasing compliance issues, so may not be desirable either.
That leaves us with monetary policy, which has already been tried with limited effect. In part that is because any increase in interest rates is being offset by an increasing money supply due to growing foreign reserves. When Beijing prevents the RMB from appreciating by buying USD assets, it increases the money supply by an offsetting amount. The scale of this is almost impossible to sterilize, so the net effect is actually an expansionary monetary policy, in contrast to the contractionary one that is required to stabilize the economy.
My conclusion is that ultimately, stabilizing the economy in China will require the rate of money supply growth to fall. A significant appreciation of the currency would certainly help, as this would reduce the growth rate of foreign reserves, and the corresponding injection of currency into the economy. An alternative would be to encourage increased capital outflows, so that the current rate of appreciation of the currency could be maintained with less official intervention.
Based on the rapid appreciation of the RMB earlier today, maybe the mainland authorities are opting for more rapid currency appreciation, although one day is hardly a trend! In sum, any action by Beijing to try to slow the money supply brings with it significant economic risks. But doing nothing and hoping for the best may bring even greater risks.
Thursday, October 18, 2007
Oct. 19 1987: Could it happen again?
Oct. 19 1987 remains the largest one-day correction in world equity markets. The DJIA lost 22.6%, and the S&P 500 20.4%. Closer to home, the drop in the HSI lagged that in New York due to the time difference. But drop it did, from 3362.40 at close on Oct. 19 to 2241.70 at close on Oct. 26- a staggering 33.3% drop. (For the data, see here. This NYT story explains the lack of data for the intervening days: the market had already dropped 11.1% on Oct. 19, ahead of the US melt-down, and was closed for the following four trading days as a result).
Could such a melt-down happen again? Nouriel Roubini of NYU and Roubini Global Economics draws the parallels between 1987 and 2007 here.
My take: yes, there are some strong parallels, and a major melt-down is certainly possible. But timing any such melt-down is extremely difficult. It could happen tomorrow, next week, next month, next year, or even next decade.
Could such a melt-down happen again? Nouriel Roubini of NYU and Roubini Global Economics draws the parallels between 1987 and 2007 here.
My take: yes, there are some strong parallels, and a major melt-down is certainly possible. But timing any such melt-down is extremely difficult. It could happen tomorrow, next week, next month, next year, or even next decade.
Saturday, October 13, 2007
Housing wealth shock... US version
When the property bubble in Hong Kong burst, average Hong Kong apartment prices fell about 66% according to the official index between the peak (October 1997) and trough (July 2003) (for a graph, click here). The result of this was a long-term recession, deflation, and general economic malaise.
The United States is now epxeriencing a bursting property bubble. Few expect the correction to be as large as that experienced in Hong Kong, and to date prices have only dropped a few percentage points. But this may be just the beginning- see this news clip on YouTube for more. Expect a similar consequence for the US economy as HK's.
Thanks to Calculated Risk for the link.
The United States is now epxeriencing a bursting property bubble. Few expect the correction to be as large as that experienced in Hong Kong, and to date prices have only dropped a few percentage points. But this may be just the beginning- see this news clip on YouTube for more. Expect a similar consequence for the US economy as HK's.
Thanks to Calculated Risk for the link.
Sunday, October 7, 2007
Sports, sentiment, and cycles....
I can't sit here, as a native-born Kiwi (New Zealander) and not make a comment on the shocking result in the Rugby World Cup in the early hours of the morning, HK time. Completely against expectations, the world's top rugby team, and the most successful in the history of the sport, lost to France in the quarter-finals. There are many things I'd like discuss (like the refereeing), but I'll leave that to the experts. The fact is, based on current form, the All Blacks (as the NZ team are called) should have won by a large margin.
Let me first address the apparent contradiction of the top team failing to win the World Cup, and then get on to the macroeconomic implications of sports, and implications for China.
Rugby teams have different styles of play. Some are flamboyant, occasionally producing amazing results, but in the long run are likely to disappoint (like hedge funds); others play excellent, exciting rugby, win more often than not, but sometimes suffer major lapses (like equities); and others are dead boring, able to grind out a modest return under most circumstances, but fail to inspire in the long run (like bonds).
Of these three types, I'd characterise the All Blacks as the top equities fund of world rugby. For over 100 years, they have out-performed all other funds across all asset classes on average, but they've had significant set-backs along the way, in particular failing to win some crucial games at world cups! But maybe that's just a result of the structure of the world cup. To win, a team must beat three competitors on three consecuative weekends in sudden-death matches. Winning two by a large margin is irrelevant if you lose the remainder.
Consider the analogy of investing. Suppose your objective was to have the highest return in three consecuative pairwise comparisons with randomly selected alternative funds. Would the top equities fund win? There's a good chance of that if all the competitors were also equity funds. But the probability drops as the investment strategies of the opposition diverge from equities. For example, equities may have out-performed bonds consistently for as long we we've had data (and have now started out-performing hedge funds as well), but I'd expect equities to beat bonds in three consecuative periods (months, say) with a probability of less than 50%, since bonds consistently outperform equities in a falling market.
Of course that doesn't completely explain the Rugby World Cup: with one victory in 5 world cups, the most dominant team is running at a lowly 20% success rate! But at least it's a start.
The semi-finals of the cup include England (bonds) versus France (hedge fund) and the winner of South Africa (equities)/Fiji (hedge fund) versus the winner of Scotland (underperforming bonds)/Argentina (inexperienced hedge fund). As with investments, it's impossible to be sure what the outcome will be.
But lets get on to the macroeconomics of sport, since this is supposed to be a macroeconomics blog! New Zealand has a small population that is completely rugby obsessed. This obsession starts at birth, and aflicts nearly all members of the population, whether they've ever picked up an oval ball or not. Perhaps more so than in any other country, the performance of the national rugby team affects the mindset, optimism, and outlook of the population.
So what happens when the national team losses unexpectedly? National mourning and stunned disbelief. But maybe more. How about a recession?
Remember that expectations and optimism play a major role in the consumption and savings decisions of consumers. In the case of New Zealand, the current phase of the business cycle would suggest that this is particularly so. As with the United States until recently, the economy has been booming, largely on the basis of the "feel good" factor. This has fueled increases in house prices to historically unprecedented levels, which has in turn fueled large increases in consumption spending and investment (in new houses), driving the economy to new heights. The end result is unsustainable, with the current account deficit at worse than 8% of GDP, and record household debt levels.
This ponzi scheme of inflated real estate prices driving excessive consumption must at some point come tumbling down. Could a shock to expectations, in the form of the worst ever performance of the All Blacks at a world cup trigger such a correction? Time will tell.
Coming closer to home, the Chinese market is a "bubble of bubbles" according to some commentators. Hype about the coming olympics may be helping to drive up asset prices above fundamental levels. What happens when the olympics is over, especially if China fails to impress with a record medals haul? It's the final straw that breaks the camel's back, and the smallest pin that bursts the largest bubble....
Let me first address the apparent contradiction of the top team failing to win the World Cup, and then get on to the macroeconomic implications of sports, and implications for China.
Rugby teams have different styles of play. Some are flamboyant, occasionally producing amazing results, but in the long run are likely to disappoint (like hedge funds); others play excellent, exciting rugby, win more often than not, but sometimes suffer major lapses (like equities); and others are dead boring, able to grind out a modest return under most circumstances, but fail to inspire in the long run (like bonds).
Of these three types, I'd characterise the All Blacks as the top equities fund of world rugby. For over 100 years, they have out-performed all other funds across all asset classes on average, but they've had significant set-backs along the way, in particular failing to win some crucial games at world cups! But maybe that's just a result of the structure of the world cup. To win, a team must beat three competitors on three consecuative weekends in sudden-death matches. Winning two by a large margin is irrelevant if you lose the remainder.
Consider the analogy of investing. Suppose your objective was to have the highest return in three consecuative pairwise comparisons with randomly selected alternative funds. Would the top equities fund win? There's a good chance of that if all the competitors were also equity funds. But the probability drops as the investment strategies of the opposition diverge from equities. For example, equities may have out-performed bonds consistently for as long we we've had data (and have now started out-performing hedge funds as well), but I'd expect equities to beat bonds in three consecuative periods (months, say) with a probability of less than 50%, since bonds consistently outperform equities in a falling market.
Of course that doesn't completely explain the Rugby World Cup: with one victory in 5 world cups, the most dominant team is running at a lowly 20% success rate! But at least it's a start.
The semi-finals of the cup include England (bonds) versus France (hedge fund) and the winner of South Africa (equities)/Fiji (hedge fund) versus the winner of Scotland (underperforming bonds)/Argentina (inexperienced hedge fund). As with investments, it's impossible to be sure what the outcome will be.
But lets get on to the macroeconomics of sport, since this is supposed to be a macroeconomics blog! New Zealand has a small population that is completely rugby obsessed. This obsession starts at birth, and aflicts nearly all members of the population, whether they've ever picked up an oval ball or not. Perhaps more so than in any other country, the performance of the national rugby team affects the mindset, optimism, and outlook of the population.
So what happens when the national team losses unexpectedly? National mourning and stunned disbelief. But maybe more. How about a recession?
Remember that expectations and optimism play a major role in the consumption and savings decisions of consumers. In the case of New Zealand, the current phase of the business cycle would suggest that this is particularly so. As with the United States until recently, the economy has been booming, largely on the basis of the "feel good" factor. This has fueled increases in house prices to historically unprecedented levels, which has in turn fueled large increases in consumption spending and investment (in new houses), driving the economy to new heights. The end result is unsustainable, with the current account deficit at worse than 8% of GDP, and record household debt levels.
This ponzi scheme of inflated real estate prices driving excessive consumption must at some point come tumbling down. Could a shock to expectations, in the form of the worst ever performance of the All Blacks at a world cup trigger such a correction? Time will tell.
Coming closer to home, the Chinese market is a "bubble of bubbles" according to some commentators. Hype about the coming olympics may be helping to drive up asset prices above fundamental levels. What happens when the olympics is over, especially if China fails to impress with a record medals haul? It's the final straw that breaks the camel's back, and the smallest pin that bursts the largest bubble....
Friday, October 5, 2007
China is a "Bubble of Bubbles".... and Ben is to Blame....
Thursday, October 4, 2007
Do bubbles slow economic growth?
"Will the presence of bubbles not slow economic growth in real economy? In China at the moment, investing in real assets may appear relatively unattractive compared with investing in equities, based on recent returns. Also, some SOE have been prosecuted for using funds earmarked for real investments to speculate in the markets instead. In the long run, is this bad for economic growth?"- Mattias
You raise a very important point. When asset prices are increasing very rapidly, firms may be tempted to divert funds from real investment to investing in equities instead. Such activity will lower overall investment, and therefore the capital stock in the long run, and must eventually reduce economic growth.
Clearly this is not an equilibrium: asset bubbles do not last forever, and when they come crashing down, firms who have engaged in such behaviour will experience substantial real consequences.
In the case of state owned enterprises, Chinese authorities are correct to try to prevent such speculation, for two reasons. First, if equity investment by SOE's has become widespread in China, then those same SOE's may face potential large losses, and may require bailing out when the bubble bursts.
Second, the diversion of investment funds into equities increases the overall demand for equities, and puts upward pressure on asset prices, contributing to the size of the bubble. Any steps by the mainland government that limit the size of the bubble are wize in my view.... I would prefer to see other and more aggressive steps taken by the government as well.
You raise a very important point. When asset prices are increasing very rapidly, firms may be tempted to divert funds from real investment to investing in equities instead. Such activity will lower overall investment, and therefore the capital stock in the long run, and must eventually reduce economic growth.
Clearly this is not an equilibrium: asset bubbles do not last forever, and when they come crashing down, firms who have engaged in such behaviour will experience substantial real consequences.
In the case of state owned enterprises, Chinese authorities are correct to try to prevent such speculation, for two reasons. First, if equity investment by SOE's has become widespread in China, then those same SOE's may face potential large losses, and may require bailing out when the bubble bursts.
Second, the diversion of investment funds into equities increases the overall demand for equities, and puts upward pressure on asset prices, contributing to the size of the bubble. Any steps by the mainland government that limit the size of the bubble are wize in my view.... I would prefer to see other and more aggressive steps taken by the government as well.
Tuesday, October 2, 2007
Mysterious Markets....
So the markets have decided that the credit crunch is over, and equity valuations have jumped. The DJIA is at all time highs, and closer to home, the HSI is growing in leaps and bounds. What is going on here?
To a macroeconomist, it can be difficult to make sense of the market at the best of times! Market valuations of equities should equal the discounted value of firms' expected future profits. But I do not believe that increased expected firm profitability is playing any more than a minor role in current market valuation rises.
The co-movement between Hong Kong and the US makes at least makes a little sense- if the Federal Reserve continues to cut rates, as the market appears to expect, then Hong Kong's booming economy will benefit as well as the US, due to our fixed exchange rate. But, based on macro analysis, I cannot avoid the conclusion that both markets are most likely overvalued.
The US housing market correction is far from over (see here and here, for example), and this alone will continue to exert a significant drag on the US economy- and on US firm profitability- in the come quarters. In the case of Hong Kong, the increase in equity prices by 35% in the last one and half months (since 17/8) simply defies rational explanation.
If I were a betting man, I know which way I'd be wagering on the next big movement in world markets....
To a macroeconomist, it can be difficult to make sense of the market at the best of times! Market valuations of equities should equal the discounted value of firms' expected future profits. But I do not believe that increased expected firm profitability is playing any more than a minor role in current market valuation rises.
The co-movement between Hong Kong and the US makes at least makes a little sense- if the Federal Reserve continues to cut rates, as the market appears to expect, then Hong Kong's booming economy will benefit as well as the US, due to our fixed exchange rate. But, based on macro analysis, I cannot avoid the conclusion that both markets are most likely overvalued.
The US housing market correction is far from over (see here and here, for example), and this alone will continue to exert a significant drag on the US economy- and on US firm profitability- in the come quarters. In the case of Hong Kong, the increase in equity prices by 35% in the last one and half months (since 17/8) simply defies rational explanation.
If I were a betting man, I know which way I'd be wagering on the next big movement in world markets....
Friday, August 17, 2007
The Beijing Olympics: a Big Deal?
I recently read a provocative article on Bloomberg claiming that the Beijing Olympics are overhyped, and less of a deal than they should be (see here). The author may be right: China is already in the spotlight, and the focus of world attention so much, that the Olympics may have little marginal effect of drawing attention to the world's most populous country.
But if indeed this viewpoint is right, then I'm worried. It is now well enbedded in the popular psychology that the olympics will be good for China, and serve to increase economic growth, improve politics and humans rights, increase inertia to solve pollution problems, and in general solve all of China's problems.
Suppose that this belief is indeed mistaken. Then we're due for a negative surprise when the olympics come and go, with little change to the underlying conditions in China. Why is this a worry? Well, markets and investment decisions depend almost as much on perceptions and expectations as they do on economic fundamentals. If the olympics are indeed overhyped, then they represent a bubble in terms of expectations. And when that bubble bursts, it may have just as real consequences as any other bubble in housing, equities or commodities. In fact, in the case of China we can view the "bubble" in equities as partly reflecting the "bubble" in expectations, that in turn reflect the upcoming olympics.
So maybe, sometime soon after the closing ceremony on the 24th of August 2008, we'll start to see the markets correct. If so, that could be more exciting than the games!
But if indeed this viewpoint is right, then I'm worried. It is now well enbedded in the popular psychology that the olympics will be good for China, and serve to increase economic growth, improve politics and humans rights, increase inertia to solve pollution problems, and in general solve all of China's problems.
Suppose that this belief is indeed mistaken. Then we're due for a negative surprise when the olympics come and go, with little change to the underlying conditions in China. Why is this a worry? Well, markets and investment decisions depend almost as much on perceptions and expectations as they do on economic fundamentals. If the olympics are indeed overhyped, then they represent a bubble in terms of expectations. And when that bubble bursts, it may have just as real consequences as any other bubble in housing, equities or commodities. In fact, in the case of China we can view the "bubble" in equities as partly reflecting the "bubble" in expectations, that in turn reflect the upcoming olympics.
So maybe, sometime soon after the closing ceremony on the 24th of August 2008, we'll start to see the markets correct. If so, that could be more exciting than the games!
Friday, June 22, 2007
Predicting Financial Crises....
Financial crises are rare events that seem to creep up on us, and then unleash a torrent of turmoil, laying financial waste to the macroeconomic environment. They seem unpredictable - in part because the final trigger of a crash may be something seemingly minor, and of little real financial consequence it its own right. Yet our inability to predict them doesn't stop analysts from trying. At any given point in history, there are sure to be some predicting a crisis just around the corner!
Sometimes it's a useful thought experiment to consider the state of the macroeconomy and try to figure out risks to its continued growth, and growing imbalances that might lead to future crises. It forces us to spell out our underlying model of the macroeconomy, and the implicit assumptions we make about financial markets.
For your bedtime reading, Mark Gilbert outlines one such thought experiment in the context of a story on Bloomberg here.
Related Reading: "Why Stock Markets Crash."
Sometimes it's a useful thought experiment to consider the state of the macroeconomy and try to figure out risks to its continued growth, and growing imbalances that might lead to future crises. It forces us to spell out our underlying model of the macroeconomy, and the implicit assumptions we make about financial markets.
For your bedtime reading, Mark Gilbert outlines one such thought experiment in the context of a story on Bloomberg here.
Related Reading: "Why Stock Markets Crash."
Tuesday, June 5, 2007
HK vs China equities....
Mainland equities continued their downward correction this morning (they've since rebounded a little)... while Hong Kong equities move in the opposite direction. Given that many companies are listed in both markets, how is this possible? The only explanation is that Hong Kong investors are ignoring price movements across the border.
Normally investors might interpret changes in share prices as reflecting new information on the underlying value of the shares. In that case, share prices falling in one market can lead to similar falls in other markets- commonly referred to as "market contagion."
We're not seeing market contagion this time around, which can only mean that Hong Kong investors are interpreting failing share prices as completely divorced from market fundamentals. Clearly Li Ka-Shing is not the only Hong Kong investor who had concluded that mainland share prices represent a bubble!
Given that Shanghai's 'A' shares started trading at a 200% premium to Hong Kong's 'H' shares, they may rationally ignore falling prices for a lot longer.... the cumulative decline in mainland share prices so far is only 16% so far.
Normally investors might interpret changes in share prices as reflecting new information on the underlying value of the shares. In that case, share prices falling in one market can lead to similar falls in other markets- commonly referred to as "market contagion."
We're not seeing market contagion this time around, which can only mean that Hong Kong investors are interpreting failing share prices as completely divorced from market fundamentals. Clearly Li Ka-Shing is not the only Hong Kong investor who had concluded that mainland share prices represent a bubble!
Given that Shanghai's 'A' shares started trading at a 200% premium to Hong Kong's 'H' shares, they may rationally ignore falling prices for a lot longer.... the cumulative decline in mainland share prices so far is only 16% so far.
Monday, June 4, 2007
Will it burst or won't it?
China equities are down 7.7% today, with over half the equities in the CSI300 dropping by the maximum 10%. They've fallen 16% since the stamp duty was trebled on May 29th. Is this the beginning of a serious correction, or just a short-term aberation? Only time will tell.
For the latest Bloomberg news story on the action, check here.
For the latest Bloomberg news story on the action, check here.
How do Housing Bubbles Burst?
Further to my earlier post, Calculated Risk provide a more detailed account. The fall in house prices in the US starting in October 1989 lasted several years. That's much like Hong Kong starting in 1997 (see this graph), although the process here was drawn out by SARS and other negative shocks unrelated to the original bubble.
The bottom line: housing bubbles can take a few years to burst.
Maybe "bubble" is not quite the best analogy of this process. How about "incredibly slowly swinging pendulum" or "feather falling in a weightless environment"? Actually, they're worse... let's stick with bubble.
The bottom line: housing bubbles can take a few years to burst.
Maybe "bubble" is not quite the best analogy of this process. How about "incredibly slowly swinging pendulum" or "feather falling in a weightless environment"? Actually, they're worse... let's stick with bubble.
Friday, June 1, 2007
The Bubble that Won't Go Away....
So the mainland stock markets have bounced back, already regaining much of the loss induced by the tripling of stamp duty. In fact it's getting worse.... the number of new accounts being opened each day has increased to over 400,000, from the 300,000 average so far this year!
It's time for more draconian measures, like a capital gains tax.
Some related links here and here.
It's time for more draconian measures, like a capital gains tax.
Some related links here and here.
Thursday, May 31, 2007
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.
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.
Wednesday, May 30, 2007
Pop Goes the Bubble (2) ????
So the mainland authorities have followed (1) from my earlier post.... they've trebled transaction fees, and the equities market have declined in response. It remains to be seen if they've done enough to prick the bubble, or even to stop it rising further. In that case, there are still (2), (3), and (4) to go....
Pop Goes the Bubble...
What do bubbles look like when they burst? That all depends on the characteristics of the market with the bubble. Sometimes it may burst quickly, like a balloon, and other times it may takes months or even years to correct.
The reason for this is that bubbles develop when market expectations of future prices de-couple from market fundamentals. Bubbles burst when those expectations change. Changes in expectations depend on the flow of information, and this varies with the market.
Take, for example, the housing market in the US. This bubble is bursting as I write.... but slowly. The latest figures show that home prices declined 1.4% in the 12 months ending March 31. How could such a small price decline represent a bursting bubble?
One key feature of housing (especially outside of Hong Kong high rises) is that houses are unique. As a result, they are highly illiquid- a sale depends on a match between a prospective buyer and seller, and few buyers will simply buy the first house they see. Matching takes time, so the market is sluggish. That sluggishness translates into information flowing slowly through the housing market, and sluggish expectations.
Uniqueness also makes determining the price more difficult. Any two houses are likely to differ along many dimensions, so even if you think that equilibrium prices may have fallen, any fall is small relative to the overall price variation between houses. Yes, average prices may have fallen by 1.4%, but the most desirable houses in a neighbourhood still sell for a price that is a multiple of the least desirable. Paying attention to the differences between houses is far more important to the individual buyer or seller than paying attention to movement in the average price.
Additional sluggishness stems from uncertainty. At times like this, many potential buyers may simply stay away from the market because they do not know which direction the price is going, reducing the number of sales that take place. Fewer sales imply less information and slower learning.
Where these information asymmetries are partially alleviated, the collapse of the bubble may be faster. For example, the price of new homes in the US dropped 11% over the past year, and some home builders expect the market to take until 2011 to recover. What's the difference between the new home sector and the second hand market? The former is dominated by larger players, selling many homes, with similar characteristics, while the latter is mostly individuals selling a single unit. The former therefore have a much better idea of the overall direction of the market. They were faster to cut prices as they recognised the change in trend. I expect that second hand homes will follow new homes down in price, perhaps by a similar magnitude, although it is not yet clear that even the new home market has bottomed out.
Equities are a stark contrast from homes. They're liquid, generic, and price is public knowledge. Up until the latest house price data was released, various analysts were speculating on what the price of housing was in the previous month! In comparison, no one has any doubt as to what the price of shares was just a few minutes ago. So when the market does change, expectations adapt quickly. Participants rapidly adjust their positions, and the market adjustment continues. This process is further exsacerbated by "stop-loss" orders, where investors can agree to sell their holdings automatically if the price falls below some pre-set limit. Clearly it's impossible to have a stop-loss order on your house!
For more on the US housing market, Calculated Risk has some excellent analysis on all the latest numbers. See also Nouriel Roubini's blog
The reason for this is that bubbles develop when market expectations of future prices de-couple from market fundamentals. Bubbles burst when those expectations change. Changes in expectations depend on the flow of information, and this varies with the market.
Take, for example, the housing market in the US. This bubble is bursting as I write.... but slowly. The latest figures show that home prices declined 1.4% in the 12 months ending March 31. How could such a small price decline represent a bursting bubble?
One key feature of housing (especially outside of Hong Kong high rises) is that houses are unique. As a result, they are highly illiquid- a sale depends on a match between a prospective buyer and seller, and few buyers will simply buy the first house they see. Matching takes time, so the market is sluggish. That sluggishness translates into information flowing slowly through the housing market, and sluggish expectations.
Uniqueness also makes determining the price more difficult. Any two houses are likely to differ along many dimensions, so even if you think that equilibrium prices may have fallen, any fall is small relative to the overall price variation between houses. Yes, average prices may have fallen by 1.4%, but the most desirable houses in a neighbourhood still sell for a price that is a multiple of the least desirable. Paying attention to the differences between houses is far more important to the individual buyer or seller than paying attention to movement in the average price.
Additional sluggishness stems from uncertainty. At times like this, many potential buyers may simply stay away from the market because they do not know which direction the price is going, reducing the number of sales that take place. Fewer sales imply less information and slower learning.
Where these information asymmetries are partially alleviated, the collapse of the bubble may be faster. For example, the price of new homes in the US dropped 11% over the past year, and some home builders expect the market to take until 2011 to recover. What's the difference between the new home sector and the second hand market? The former is dominated by larger players, selling many homes, with similar characteristics, while the latter is mostly individuals selling a single unit. The former therefore have a much better idea of the overall direction of the market. They were faster to cut prices as they recognised the change in trend. I expect that second hand homes will follow new homes down in price, perhaps by a similar magnitude, although it is not yet clear that even the new home market has bottomed out.
Equities are a stark contrast from homes. They're liquid, generic, and price is public knowledge. Up until the latest house price data was released, various analysts were speculating on what the price of housing was in the previous month! In comparison, no one has any doubt as to what the price of shares was just a few minutes ago. So when the market does change, expectations adapt quickly. Participants rapidly adjust their positions, and the market adjustment continues. This process is further exsacerbated by "stop-loss" orders, where investors can agree to sell their holdings automatically if the price falls below some pre-set limit. Clearly it's impossible to have a stop-loss order on your house!
For more on the US housing market, Calculated Risk has some excellent analysis on all the latest numbers. See also Nouriel Roubini's blog
Saturday, May 26, 2007
Ignorance is NOT bliss....
From Saturday's SCMP, the Mainland National Social Security Fund chairman Xiang Huaicheng was reported as saying
"the holders of the 100 million stock investment accounts include retirees, teachers, civil servants and even monks, most of whom do not understand the stock market."
And this is supposed to be re-assuring? See my earlier comments here.
"the holders of the 100 million stock investment accounts include retirees, teachers, civil servants and even monks, most of whom do not understand the stock market."
And this is supposed to be re-assuring? See my earlier comments here.
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