Air starts to hiss out of China’s market bubble

published 7 December 2007

China's domestic stockmarket bubble has sprung a leak. The Shanghai Composite index is down 20% from its peak.

Weekly trading volumes have also slid rapidly over the past two months; having hit 17 billion this year, in late November just 3.3 billion shares were traded, says John Authers on FT.com. It looks as though the market is heading back down to earth.

Over the past few years, local investors have poured into the mainland market which is largely off limits to foreigners to profit from China's sizzling economic growth; there are now 108 million brokerage accounts, 35 million up on last year.

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But it seems investors are beginning to worry that recent measures to cool the market and the economy, including five rate rises and controls on bank lending, will lower profit growth next year, "so the market outlook is gloomy", a Shanghai fund manager told the China Morning Post.

And profit growth isn't all it's cracked up to be anyway. "Companies big and small are playing the markets with abandon," says Frederik Balfour in BusinessWeek. Morgan Stanley reckons that about a third of reported earnings stem from non-core investments, which, in almost all cases, means equities.

Another estimate says that as of 30 June this year, 494 listed firms had stock holdings worth $45.6bn, compared with $2.3bn held by 163 companies a year earlier.

The danger is that a sliding market depresses investment profits, damaging companies' earnings and hurting their stock prices, pushing the market down quickly. This "snowball rolling downhill" scenario, as Morgan Stanley puts it, is exactly what happened in Japan in the late 1980s.

What's more, as Balfour says, given that firms have been bolstering their bottom lines by playing the markets, the conventional wisdom that corporate China and hence the real economy will barely be affected by a sliding stockmarket "is looking suspect".