Chinese Stocks Technically in Bull Territory

November 6th, 2015 by

By definition, the Shanghai Composite index, China’s benchmark mainland stock index, has entered another bull market. However, this fact can be deceiving, and is more of a function of how far the index fell earlier this autumn.

Nonetheless, headlines have been touting the return of the “bull market.” Be wary of this cherry-picked data, as we will see below.

Meanwhile, Back in the Real World . . .

Technically speaking, when a market rises 20% above its 52-week low, it is considered to have entered into a bull market. Not only is this percentage-based definition somewhat arbitrary, it also doesn’t tell the entire picture. All it’s intended to signal is that a particular market has been rising and may well continue to trend higher.

china-stockSo, the Shanghai Composite has indeed risen 21.08% above the lows it touched back in late August. As impressive as this sounds, it must be put into perspective before you consider jumping onto the supposed gravy train.

Over the past two months, and during October especially, the index gradually moved back to a reading near 3,600, a fresh 2-and-½-month high. Yet, over the preceding two-month period from mid-July to mid-August, the Shanghai Composite plunged from its all-time high above 5,175 to below 3,000—a loss of 42.7%. The rout wiped out an incredible $5 trillion in value.

A quick check of the chart below reveals how shallow the recent “bull run” is compared to the staggering drop that led up to it.

SHCOMP 6-month price chart

SHCOMP 6-month price chart. Source: Google Finance

Chinese IPOs Resume

Adding to the resurgent market sentiment regarding Chinese equities has been the announcement that the state will once again allow companies to issue initial public offering (IPO) share sales. IPOs for companies trying to list on the Shanghai Composite were suspended at the beginning of July. Most of those firms will be able to resume the process beginning on November 20th.

The resumption of IPOs follows improvements made to the index’s listing system. It also reveals the government’s improved confidence in the stock market. The chart below from Bloomberg shows a broader picture of the Shanghai Composite’s performance over 2015 so you can see how high the rally actually went before the crash.

china_bull

Free Market?

china-flag-shanghaiChinese regulators control timing and pricing of new listings, unlike most other stock markets in the West where a standard protocol governs how firms determine an initial listing price for themselves. In Shanghai, they generally undervalue newly-listed companies so that their shares appear to rise: by consistently listing firms at prices below 23x earnings, the regulators almost always ensure that the stock will experience a nice surge once the listing begins trading.

Beyond these kinds of gimmicks, anyone who believes that the Shanghai Composite is poised to swiftly return to its highs from earlier this year will be at a loss for explaining why it fell in the first place. Does this mean it wasn’t a correction (or, better yet, a bubble bursting), but was merely due to “manipulation” by “insidious foreign speculators”? If that’s how you see it, you’re directly in line with the propaganda from Beijing. To call it a “bull market” is little more than cropping the data. Caveat emptor.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.