Why reckless Chinese investment suggests a looming stock market bubble

China stock market abstract

China’s stock market has doubled in value in the past year. It’s remarkable rate of growth is attracting new investors at an alarming rate.

During China’s economic boom, when growth rates averaged above 10%, investors weren’t as bullish on stocks. Now that economic growth has slowed, they can’t get enough of them. So what’s caused the sudden turnaround?

People often say that the Chinese are careful with their money. They save everything they earn because the government doesn’t provide them with a safety net.

But that’s all changing. And the rate of it is quite astonishing. Young Chinese investors who’ve grown up in an age of economic prosperity are more bullish on chasing higher returns. And they’re having an effect on their parents. Almost two thirds of new stock market investors never completed high school.

That’s hardly surprising, given this next bit of news. The AFR reported that stock markets are heavily featured in popular tabloids. Small wonder then the average Chinese person is flocking to join the rush. Five million new trading accounts were opened in March alone.

The market capitalisation (the value of all shares in the market) of the Shanghai Stock Exchange added over $5 trillion in the past 12 months. To put that in perspective, the ASX has a market cap of $8 billion.

How government policy influences stock market investments

The Chinese share market will continue to grow, because the government wants it to. A surging stock market isn’t necessarily a bad thing. But China is different — because of where the push is coming from.

Chinese analysts realise that stocks are flourishing because the government wants people to invest in equities. And they’re making it easier for investors to do so. Just recently they made it simpler for pension funds to invest in stocks. And even the central bank has given favourable signals to invest in shares.

The government is opening up the share market to prevent a further slowdown in economic growth. The 7.4% growth rate for last year is well below the 10% rates of a few years ago. Economists predict growth of just around 7% for 2015. So the Chinese government wants to steer public money into giving the economy a nudge in the right direction. But why stocks?

The reason for this is because a significant amount of China’s debt is tied up in real estate. That’s why the government wants more money flowing into stocks — and away from housing.

The idea is that some of China’s unpayable debt would move into equities. So far that’s proving to be the case. This, in theory, would provide companies with more capital to pay out their debts.

So you can see why the Chinese government is taking this route. The more optimistic observers even think this might lead to increased consumer spending. This could pave the way for a smoother transition to a consumer led economy — at least in theory.

As long as China has a rampant shadow lending sector, it’s difficult to accurately predict what the future holds for the stock market. The Daily Reckoning’s Phillip J Anderson believes this shadow sector makes China unique. In his free report, ‘The Cassandra Syndrome: After This Report, You Won’t Worry About China Again for Another Decade’, Phil explains the four reasons why a Chinese economic crash isn’t imminent. To find out how to download Phil’s report, click here.

Mat Spasic,

Contributor, The Daily Reckoning

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The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.

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