US$6.5 trillion is a large sum of money in anyone’s language. Taken in isolation, that figure would represent the second largest stock market in the world. The scary thing is that this is the value by which China’s stock market has grown in the past 12 months alone. Its actual market cap stands at US$9.7 billion.
In other words, Chinese investors sent the value of Chinese stocks skyrocketing by 67% in the past year.
This mindboggling growth in Chinese equities is unprecedented in history. It easily eclipses the growth seen during the dot com bubble in the late 1990s. And we know how that ended…
What’s even more concerning is that this development comes at a time when China’s economy as a whole is slowing. But is there a correlation between China’s economic slowdown and share market growth? It seems so.
Looser monetary policy has freed up lots of capital for investors. On top of this, bank lending requirements have been lowered. Both of these have contributed strongly to a surge in equity investments.
We also must not forget that that the Chinese government has made a concerted effort to push investors towards stocks. If you can believe it, stocks investments are even promoted in popular tabloid magazines.
Why Chinese investors are flocking to stocks
The reason why stocks are so attractive all of a sudden is because of fears over the property bubble. The Chinese government wanted to see more investors diversifying their investments. The idea is that it would ease some of the pressure that was weighing down on housing. And that’s why they’ve steered investors towards new asset classes like stocks.
As you can see, equities have morphed into a monstrous problem of their own. They are growing so wildly that they may end up replacing real estate as the major concern for China’s economy.
The Chinese government won’t see it that way — at least not initially. But the evidence is mounting that China’s stock market is setting itself up for a major crash in the future. How could it not? You only need to look at the sheer number of new retail investors entering the market to see the pitfalls ahead.
Investors have borrowed $350 billion in the past year to take advantage of the stock market’s exponential growth. That’s not just confined to seasoned investors either. The worry is that everyday Chinese mums and dads are getting in on the action. A record 4.4 million new trading accounts were opened in the final week of May. That’s led to the highest price to earnings ratio seen in over five years.
Unsurprisingly, Chinese investors still view the market with optimism. While the going is good, there’s the expectation that things will only get better.
On top of that, economists are easing any fears investors may have. Some economists believe the government will keep the stock bubble rally going. Why? Because companies need fresh capital. And the government is prepared to accomodate that wish. It would certainly make sense after all. At the beginning of January, debt levels for companies across the Shanghai Composite Index (SCI) reached their highest levels since 2005.
But outside of government help, there is another factor that could push Chinese stocks even higher over the next few years.
Why tomorrow is a big day for China’s stock market
China’s bulls are banking on a major decision by the MSCI Inc. tomorrow. MSCI is best known as a publisher of the MSCI World and MSCI EAFE Indexes. They’ll be ruling on whether Chinese stocks are eligible for indices used by $9.5 trillion of funds worldwide.
Doing so would open up Chinese equities to foreign capital that has up to now been off limits. But, if MSCI rule the other way, it would come as a massive blow to investors who have pushed up the SCI to unprecedented heights over the last year. That’s because investors see this as the next great push to lift share prices — and their profits from this.
Either way, it’s strongly expected that the Chinese government will endorse a further stock market rally. In the short term at least, Chinese equities will trend in one direction only — up. Opening up Chinese stocks to global indices would provide another huge boost to the share market.
That makes it difficult to tell when China’s rally will end. But when it does, it has the potential to wipe out those Chinese investors who’ve poured their savings (and debt) into stocks. Unlike the property bubble, there’s nothing solid about stocks. It has all the makings of a spectacular crash.
Contributor, The Daily Reckoning
PS: China’s stock market isn’t the only one with clouds hanging over it. The Australian Stock Exchange has it’s fair share of ongoing concerns too.
The Daily Reckoning’s Vern Gowdie believes we’re going to see a catastrophic crash in stocks. Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s been ranked as one of the Australia’s Top 50 financial planners.
Vern believes the ASX could lose as much as 90% of its AU$1.8 trillion value in the future. That’s why he’s written a free report, ‘Five Fatal Stocks You Must Sell Now’, to help you protect yourself from the fallout.
In this report, Vern wants to help you avoid the coming wealth destruction. He’ll show you five blue chip Aussie companies in particular that could destroy your wealth…and you almost certainly one of them. To find out how to download the report, click here.