Chinese Stock Market Cracks

The Wall Street Journal ran an interesting front page article this weekend on the Chinese stock market, “China Stocks, Once Frothy, Fall By Half In Six Months” (subscription required).  The chart tells the story: Shanghai Index Chart.

It was obvious that Chinese stocks were in a bubble and I’ve been writing about it for at least year.  See, for example, “The ‘Sell China’ Chart”, Top Gun FP, April 24, 2007 – (note that the link to the chart has now changed and is not correct).

Of course, I was early and reading this article just reminded me that the difficult part is always the timing.  There are always people who have the independence of mind to see what is on the horizon where others don’t.  But the timing always depends on some kind of “tipping point” which is primarily a function of psychology, of the crowd finally coming to see what’s going on.  That’s what makes timing so difficult.

The other thing the article made me think about is what this means for stocks as a whole.  I think it does carry wider implications.  China is one of the big stories of this bull market, the corner stone of “the global growth story”.  And while China’s stock markets are mostly closed to foreigners, many US investors have invested through the China ETF (FXI). 

I think that China’s stock market can be thought of as a measure of investor sentiment.  That is, for quite a while now it has traded on emotion not fundamentals.  And so the breakdown signifies a shift in investor sentiment.  It’s no surprise the Chinese stock market peaked on October 16th, 2007 right around the time the US market peaked (Oct. 11).

Like the yen and the VIX, the above chart tells you a lot.  It tells you that we had a substantial tipping point in psychology and while China may be bouncing right now along with the rest of the market, we are not likely to reach the old highs or recover the same level of euphoria for a long, long time.

Disclosure: Top Gun has no position in the China ETF (FXI).