Discussion on Renminbi and its related issues II - Diagnosis of Chinese asset price level

This is the continuation of my previous studies on the Chinese economy and Chinese stock market. Before the further analysis, I would like to repeat some conclusions from previous study for reference.

- In Trend of the Chinese Stock II and Market swallows Katamine, I conclude that policy intervention will lead to change of expectation causing harder control.

- In Trend of the Chinese Stock III, I intend to argue that Chinese companies do not surely win.

In the series of Trend of the Chinese Stock, I finally conclude that the Chinese bubble is not far away from our imagination. Yet, recent continue surge ignited by the increase of interest rate and the appreciation of Renminbi lets me re-assess my previous logic. That is to evaluate carefully on what level of impetus for the Chinese stock market is.

Besides, I would like to post links concerning the Japanese asset price bubble and Japanese Yen in 1980s for your reference.

- Japanese asset price bubble in 1980s (Wikipedia)
- Japanese Yen (Wikipedia)

In order to reflect the current situation in China, some editorials used to adopt that as an example of over-heating and frenzy speculation on the asset markets (stock and real-estate). Chinese government should be familiar to this dreadful history. Regarding the potential stronger appreciation of Renminbi, on the one hand, how can it develop the potential asset bubble in China stock market (or Hong Kong stock market)? On the other hand, how would the Chinese government combat the bubble formation?

- Adopting Japanese asset price bubble to construct scenario

If using the Japanese scenario as the template without Chinese characteristics and policies, we can speculate that even if China increases the nominal interest rate, the market anticipates the appreciation of the currency value, and then the asset value. This becomes a die-hard cycle under the negative real interest rate. The people would be willing to take margin in order to enlarge the size of their asset. The banks would adopt looser credit policy.

Finally, this attains a highly unstable state, where self-fulfilling prophecy will prevail (for example, intolerable high inflation, a sudden bank run, or some irrelevant economic shocks) to turn the asset price bubble upside down, and finally affect the economy through the failure of banking industry, and spread to other sectors. The price level, including the currency value would then decrease.

- Different case in China

In terms of the background and people's sentiment, China does have the similarity when comparing with that of Japan in late 1980s. However, there are some differences.

• China is a relatively close in the financial market such that on the one hand, people are not capable of investing in the foreign countries easily. On the other hand, the foreign capital instilled into China is not as large as the ordinary open financial market. Therefore, the recent surge of Chinese stock market is mostly due to the flooding of liquidity from the Chinese investors or speculators themselves.
• In term of Chinese fundamental economy, despite my old essay concerning the slower growth, its overall growth rate is still much higher than that in Japan in late 1980s. Therefore, one may contend that the current situation is not so serious.

What kind of possible scenario can we see in the future?

(Continue, with different essay title)

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My previous related essays
- Market swallows Katamine
- Trend of the Chinese Stock I
- Trend of the Chinese Stock II
- Trend of the Chinese Stock III
- Discussion on Renminbi and its related issues I

A wily hare has three burrows - Some wisdom in investment

Recently I just observed someone discussing about his anxiety on the failure of US dollar and global economy in the future. In view of this, he wanted to choose some other assets to evacuate. This lets me brainstorm some ideas on the investment strategy. This is, according to a Chinese idiom - A wily hare has three burrows (狡兔三窟) , to explore where the wily hare is. What is the meaning of wily hare?

- Time lag of bullish moment for different assets

The wily hare can be regarded as the "bullish moment" in the economy. Intuitively, even in the good economy, the bullish moment may not totally arrive at all parts, all industries, or all assets in the world. Sometimes, some assets cannot enjoy the benefit of general good economy under the main cycle. However, when the good economy reaches the saturated situation, the good prospect disappears in most parts of the world but starts at the other parts, other industries, or other assets.

That's related to another important wisdom - In the bearish regime, there are still the cases that some stocks or assets have good prospect. From my point of view, excluding the cash at hand (too defensive, unless the rare case in 1930s), short-selling or put (Trivial, but it is too risky and they involve complex techniques), we can try to discover the other bullish markets.

- In terms of location

If US economy declines, which locations should we invest? Chinese economy and its stock market are rather close. Is it a good means to invest in Chinese market as a shelter? Notice that the PE ratio for this market is already very high. People investing in this market have entered the stage of expected asset appreciation.

As for Korean market, it also has the reputation in the technological development among the emerging market, but its PE is lower comparing with the other places. Notice that it is more open comparing with the Chinese market. How is the trade-off between them?

- In terms of industry

Some people contend that nowadays the stock market does not have the unilateral trend since the performance in different industries matters. In US, the stocks in the financial sector and property sector plummet, but the stocks with information technology as background surges without being undermined by the market sentiment.

Looking ahead, we can see that Chinese stock market is rather driven by the asset appreciation so that most of stocks in financial or property industries will surge. If we take up the precautionary measure for the sake of the potential bubble burst, is it sensible to invest in those industries related to the engineering and infrastructure so as to mitigate those risks? If the value of these stocks are still not appropriate, can we find those industries with low PE ratio in order to enhance the defense power?

- In terms of type of asset

In the past, when the people are not confident of the economy and the money in the market (due to high inflation), people will rather hold gold to preserve the value. In the modern age, if the recession occurs, which asset will become dominant? Will the commodities like copper, iron and aluminum surge owing to the increase of infrastructural development in the recession? How would be the soft commodities like ethanol or corn since the stock market may be disturbed by some of the shocks in the commodities market?

People seldom mention the foreign currency, as it fluctuates in the seasonal and mean reverting pattern. Therefore, it can mostly have the speculative purpose instead of bullish or bearish perspective in the normal circumstance (floating exchange rate). Foreign currency can only be the short-term shelter under the bearish regime in the stock market.

- Conclusion

To switch into another burrow is a traditional wisdom in investment. Regarding the industry, someone may be afraid that the whole stock market around the world or industries will be devastated by the shocks. Therefore, instead of the stocks, other assets can be the choice for the switch.

Ideally speaking, to be more aggressive, we can invest in the locations, industries, or assets which are away from the focus when we see that people become over-optimistic towards some stocks in certain locations or industries. Of course, we still need further analysis to explain such kind of move. The final profitability still depends on the experience or psychological aspect of the individual.

Diversification and complement

There are two concepts which are very important in finance, economics and investment. They are diversification and complement.

For the diversification, it is more frequent to occur in finance and microeconomics (as a part of uncertainty). It is a kind of risk management not to let the whole portfolio or business ruined by certain unfavorable conditions. Although the probability to get ultimately high return is reduced, the chance to get rid of the effect of the shocks owing to failure of its business or industry is higher. For the complement, it is rather synonymous in economics. The counterpart of complement is the substitutes. A complement of a good, says good A, can have large amount of demand if good A has increasing demand.

I would like to share my thought on these two terms, and apply these basic ideas to stock-picking practice. Note that realization of these practices is rather long-term. Under the market risk spreading throughout the world, those firms equipping with these weapons still cannot escape from the risk, but at least they are one of the pillar to withstand the adverse market condition and stand for the symbol of confidence.

- Diversification

The diversification can be enacted by the stocks like the conglomerates. However, from my point of view, some conglomerates may sometimes lack targets for its development. This can be seen through the objective of the management, where some management change the objectives frequently, and finally do not capture any market share. This is somehow the misuse of diversification.

Therefore, my view in diversification will be on the vertical integration of a firm. The vertical integration of the firms means that the firms can manufacture both the raw materials and the end product. In this kind of framework, the firms can possibly reduce its risk of exposure in price fluctuation in raw materials.

Theoretically, diversification has some slight difference with another concept called hedging. Hedging in the price fluctuation, including exchange rate fluctuation, can succeed with the assistance of the derivatives like the future and option. Different from diversification, this involves the financial derivatives instead of alternative products.

Firms being the example of diversification include Petrochina Co. Ltd. and China Shenhua Energy Co. Ltd.. I appreciate their diversification through the vertical integration so as to reduce the fluctuation of income. In terms of hedging, Cathay Pacific is well-done in its hedging tactics for the oil price.

- Complement

The complement can be enacted by the following example. The automobile market in China becomes larger because of the following reason. They include the larger consumption power of people in China. China evolves to be an automobile manufacturing center in the near future since China starts to achieve economy of scale and technological progress, together with important cost advantage comparing with its neighbor. Apparently, Automobile market is quite prominent and firms conducting automobile manufacturing should have good prospect.

Yet, not all the automobile firms can gain good prospect owing to certain competition and energy requirement from the central government. Moreover, within the family of automobile, there have internal competition and segmented market. Therefore, the risk level of each firms are different and some firms which cannot achieve the advantages would have substantial risk.

Putting the automobile market aside, could we see that in another market, tire market, will become the complement of automobile since all automobiles need tire. If you are afraid that the tire market is too competitive, the market for the highway can also become the complement of the automobile. It has higher profit margin and stable income.

- Conclusion

The above ideas are just some intuitive examples to illustrate how the concepts of diversification and complement work. My idea is, diversification reduces the weakness and risk, while complement enhances the opportunity and strength.

To truly realize the power of these weapons, you can just emphasize on the duration of the investment and the overall market environment. Moreover, other factors have to interact with these tools in order to enhance the probability of success in investment.

Busy soon...

Yesterday I decided to sell two more stocks since firstly, I think that the odd to pursue further in this stage is little (by use of the technical analysis). Even if it succeeds, the volatility will exceed the gain. As a risk-averse person, I cannot afford that. Secondly, currently I am busy on my works so that I don't want to be cursed by the stocks. Currently I have 85% of cash. The rest consists of two stocks. One was bought from the IPO many years ago, while another was bought for the long-term investment.

Therefore, now I firstly experience the period of 85% cash since June 2006. In April (or May), I would return back for shopping in the equity market. Some targets are defined now.

1. Appr. 20% of the cash is for growth stocks.
2. Appr. 30% of the cash is for stocks with high yield.
3. The rest will remain the cash, or switch them to the Renminbi if it's possible.

The market for commodities like crude oil and conventional metals

Yesterday I focused on an essay on the Renminbi and its related issues. When I started writing the second part regarding the asset price bubble, I found that it requires certain organization in the logics and information. I think that it cannot release in the short period of time. Anyway, some apparent result is, the appreciation in Renminbi can bring lucrative opportunity for the China Enterprise stock, but they would probably go out for hiking. (Discuss this again when I organize that well. Welcome to comment.)

By the way, noticing some people discussing about the price of the resources, I suddenly think of some ideas concerning the price of the commodities in the short to medium term. Here I would share with you about my ideas concerning the commodities such as crude oil and conventional metals.

- The political status (Concerning the crude oil): Recently the case in Iraq has been eased gradually. It is possible that the price of the crude oil will be decreased as soon as Iraq needs to pay the reconstruction fee through selling their oil deposit, according to recent meeting among the stakeholders. Once I also read an article saying that the cost to extract oil from the ground of Iraq is pretty cheap where outdated technologies are enough to carry out oil drilling.

You may refer to the article of Mr. Lam from Hong Kong Economic Journal (Mar 7, 2007) as reference.

Moreover, the current situation in the six parties talk shows that the tension between North Korea and US can be eased. Therefore, the situation brings a stable message towards the speculators.

- Possible contraction in US: US is possibly under the slower growth rate in this year. Therefore, it may bring down the demand of the crude oil and the conventional metals. Especially, when the growth of newly established houses is reduced, possibly it provides signal that the price of these commodities may be turned down.

- Possible contraction of liquidity: Japan is struggling to go out of the liquidity trap so that the interest rate starts to increase. This may stop the vigorous overspread of the liquidity to different kind of asset, including the crude oil and metals. Therefore, unlike past few years, we can see that the price for the resources can hardly increase.

- Weather (Concerning the crude oil): The temperature seems to be hotter than before. Moreover, entering the summer, it is possible that the demand of the crude oil would be reduced.

- Substitutes (Concerning the crude oil): The crude oil now has the main substitute like alcohol. In the very long run (notice it is very long-run), the price of the crude oil may be reduced since there is compatible competitors. Yet, in the short-run or medium term, it seems that the cost to produce alcohol in scale is much higher as it needs special equipments and technologies. Therefore, the threat from the substitute is mitigated.

You may refer to the article of Mr. Cho from Hong Kong Economic Journal (Feb 10, 2007) as reference.

- Emerging market: It is indeed true that under the rapid expanding economies in China and India, the demand of raw materials such as crude oil and metals should increase a lot. Yet, it is not overwhelmingly optimistic that these economies can support the demand of these raw materials*. Let's see that China now concerns the negative externality of the manufacturing product such that it should bring less pollution to the environment. This may lever the production cost of many manufacturing products and reduce the demand of the raw materials.

- Conclusion

After the above analysis, I feel that the price of most raw materials will remain stable. I would say that the probability to have the bullish pattern developed in the past few years is small. For some of the commodity which is rare for some important manufacturing products, there is still hope that the price will increase, yet it is due to the lack of supply.

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* The idea of decreasing demand of different kinds of metal has been discussed in Mr. Cho's article of HKEJ on Mar 14, 2007, where it mentions that the actual demand of the metal may be declined through the high price developed in past few years. He mentioned that the metals' supply now has the pattern of over-production.

* * *

Today Petrochina Co. Ltd. released its financial performance. It is somewhat disappointing. it seems that the decrease in oil price cannot ease its cost of production in petroleum products. Together with the decrease sales of crude oil, it leads to much slower growth. Once it was my beloved stock because of its good management. Now it really needs to face the challenge under the consolidating regime.

Essay related:
About Petrochina Co. Ltd.

Discussion on Renminbi and its related issues I

On March 17, 2007, The People's Bank of China (PBC, central bank of China) announced that both the lending and borrowing interest rate will be raised by 0.27%, effective on March 18, 2007.

Yesterday when I read the discussion in the forum, I found a simple but challenging question concerning the action done by the People's Bank of China. The question is, if the interest rate of Renminbi (Currency of People's Republic of China) increases, will it force the currency to appreciate in a much larger rate (faster pace)? Apparently, the answer is yes, yet it arouses some concern on Chinese economy. In view of the above question, I would like to have some simulation on this.

- How is PRC's concern?

If the increase in interest rate forces the appreciation in Renminbi, I can think of two aspects.

• Current account revenue will be dampened owing to ordinary price increase.
• Capital account will be increased owing to appreciation attracting foreigners to buy Chinese asset.

Since there is still foreign capital control on the capital account, the second effect will be limited. This can overall lead to reduction of the inflow of foreign reserve like US dollar. The curse in our mind is, if Renminbi appreciates i.e. US currency depreciates, it will decrease the value of the foreign reserve. Moreover, the appreciation together with the US weakened economy may hinder the growth of the export industry in China. Are these things inconsistent to the policy of the Chinese economic development?

There is the fact that Chinese government conceded the vast amount of foreign reserve cannot be the optimal means to utilize the resource. It recently decided to establish the foreign reserve management company, similar to Singapore's Tamasek, to manage the foreign currency actively. From this point, it has some implication that Chinese government concerns more on the utilization purpose of the foreign reserve. Therefore, it favors the appreciation.

On the other hand, Chinese government recently also announced the rebate of the export tax will be reduced or even cancelled. This is also the thought so as to reduce the current account revenue between China and some developed countries like US. From my point of view, it was firstly to comply with some WTO standards required before. Secondly, it was also a means to maintain the depreciation pace of US dollar stably. The dampen US current deficit can be a signal to relieve the curse on US dollar depreciation against the currency of main economy in the world. The rapid depreciation of US dollar will be the disaster to ignite the ruthless Japanese Yen carry-trade.

After above considerations, it has the following considerations. Firstly, it seems that the above ideas are really detrimental to the export firms, together with the potential decline of US economic growth. That's why I do not encourage the investment in export sector unless the company has comprehensive hedging tactics and marketing strategies. Secondly, the Japanese asset bubble in late 1980s is etched in my mind. This is caused by the sharp appreciation of Japanese Yen in 1980s. How will Chinese economy become? I will continue to analyze that.

(Continue)

* * *

I remember few years ago, when I attended a public seminar concerning the appreciation of Renminbi, a researcher of an investment bank said that the appreciation on the Renminbi would also exacerbate the income inequality in China since the poor who export the agricultural product would lose the competitiveness through the appreciation. Now that the Chinese government uses other resorts such as abolishment of taxation on agricultural product, I think that there must be protection on the basic production side.

Time Lag of news - New age, New tactics

Stock market is not only a volatile place for the stock price, but also for the news and methodology of trading, as there are usually innovations. The techniques that we learned before may not be easy to be applied to the current stock market. I just read two articles from Mr. Cho and Prof. Tsang. These two articles reveal some observations that we have to be prudent with flexibility instead of following the old rules.

For Mr. Cho's article, it mentions that the stock market has lost its predictability in real economy. Originally, before 1980s, the stock price was an effective leading indicator to the real economy so that when the stock index falls, it implies the macroeconomy will be deteriorated soon.

However, in 1987, the stock crash was a wrong alarm to the economy such that the economy maintained its strong growing status. As for 1997, Hong Kong stock market got something strange as the financial crisis (real economic shock) had started earlier than the downturn of stock market. Moreover, in 2000, the HSI seemed to go in an opposite way against the real economy. Finally it was found that HSI was even lagged behind most of the indices like US and Japan's indices.

As for Prof. Tsang's article, it mentions the new tactics occur in the recent market environment. The past wisdom told us that we could see how the HSI future implies the market movement of the stock price. In the adjustment regime, the speculator would determinedly short-sell the HSI future so that the open interest of HSI increased. Recently under this regime, the open interest reduced since more thoughts or precautions are instilled into the speculator's mind.

He also mentions in US, the news detrimental to the economy is released earlier. But the speculators may artificially pretend that they haven't heard the news since they didn't have the short position. As soon as they gained enough short position, they would produce certain rumours and reproduce the news so that it strengthened their short position. It's somewhat similar to the case of a big drop where the news from a renowned researcher of an investment bank was reproduced, even if that message has been released a week before the big drop.

Therefore, from this experience, we should be independent to think of the perspective of the economy. Recent news about the increase in PPI did not force US market to drop (noticing that if the situation exacerbates, the worst outcome can tend to the stagflation, which is the most acute problem in macroeconomic policy issue), while recent precautionary messages from the central bank of China and prime minister Wen Jiabao do not produce permanent effect in the drop of Hong Kong and Shanghai stock index. Can we trace what the big players are thinking?

* * *

Luk sir has just written another article regarding the attitude in investment for the young people, which is the part III continuing the previous two.

- Third Part

Short notes (Mar, 14, 2007)

This is my brief record. I advise people not to follow that much.

- Equity market environment

• Global market: Slight bearish except that it sheds little bit light on some industries in China;
• Industries with the best prospect: Airport and support for airline, Infrastructure, Construction, rare metals (for other industries as raw materials);
• Industries with good prospect: Airline, Banking and Finance (China: With good vitality and innovation; Hong Kong: Ambitious aim at Chinese market), Property (Large firms or based in Hong Kong with significant proportion in China), Consumption (China: Depends on the concentration and elasticity of demand of goods or service), Consumption (Europe: Luxurious goods), Coal mining;
• Technical status (AI): -5, -4, -3, -2, -1, 0, 1, 2, 3, 4, 5;
• Technical status (AII): -5, -4, -3, -2, -1, 0, 1, 2, 3, 4, 5;
• Technical status (BI): -5, -4, -3, -2, -1, 0, 1, 2, 3, 4, 5;
• Technical status (BII): -5, -4, -3, -2, -1, 0, 1, 2, 3, 4, 5;
• Aggregate sentiment: -5, -4, -3, -2, -1, 0, 1, 2, 3, 4, 5.

- Retrospect Indicator

• My sentiment: -5, -4, -3, -2, -1, 0, 1, 2, 3, 4, 5;
• Independence: -3, -2, -1, 0, 1, 2, 3;
• Rationality: -3, -2, -1, 0, 1, 2, 3;
• Long-term mindset: -3, -2, -1, 0, 1, 2, 3;
• Discipline: -3, -2, -1, 0, 1, 2, 3;
• Cash vs asset management: 70% Cash.

- Report (Written on Mar 15, 2007)

On March 14, I would like to make a trade for China Airline, yet I eventually gave up this trade. To support this trade, the reason is due to the long-term prospect in airline industry and its short-term advance in net income owing to decrease in oil price. Its management team is good to my knowledge. Moreover, there is much space to have strategic development with other members, such as Cathay Pacific, in the industry. In terms of bid-ask trading, coincidently I saw that there is strong buyers like investment bankers willing to purchase this in large amount. This kind of situation is rare, which boosts my instant confidence to buy this stock.

However, I rejected this opportunity because I believe the market environment is deteriorating and it should be just a pullback, despite its strength yesterday. Now the situation is mainly for the short-term traders, whereas I am not always sensitive to the volatile environment. In term of pricing, it is reasonable, but it does not match a normal aggregate sentiment. Therefore, this implies certain discount is needed to convince me that it is a good buy. Moreover, This stock was not in my observation list, while I could pick it out because of coincident search under my memory. I will not take action under no preparation.

This stock was one of the three H-share which remained to surge yesterday. It continued to surge today. I believed it has a bright future, yet it needs a good market environment to support.

Long-term versus Short-term - Talking about strategy

In the almanac of investment, we can see that there are two approaches which have been pronounced for a hundred years since Dow Jones Index was established. These are named as the fundamental analysis and technical analysis. Actually, two similar philosophical aspects align with these two approaches. They are long-term investment and short-term investment.

Long-term investment is sometimes labelled as value investment (actually it is not correct) as it concerns the analysis in the financial statements, while short-term investment is just the speculation which relies on the skills in technical analysis and psychological control. Two sides of people often contend that their opponents cannot earn much comparing with their own. They usually focus on the representative guru as a means to prove their own success. For fundamental analysis, Warren Buffett, Peter Lynch, John Templeton are usually quoted as the confidence of long-term investment, whereas George Soros and André Kostolany are mostly regarded as the sophisticated speculators in history of finance.

- I think it depends

From my point of view, I think that it seems that it resembles the paradox - the blinds would argue what an elephant looks like. Therefore, one should notice that different people have kind of preference and needs. Moreover, different time may have different strategy. The whole philosophy cannot be adopted to all the people and all period of time.

For example, age does matter in deciding one's strategy. The amount of capital one owns may also matter. Personality and the sentiment at a sudden moment are also another concern. In addition, thanks to the generally inefficient market, some important aggregate characteristics are the important signal for whether we should adopt the long-term investment or short-term investment (speculation). Therefore, it leads to diversified strategies.

- My belief

As for me, I am used to making certain top-to-buttom analysis so as to examine the proportion of long-term and short-term investment in my mind. At first, I will look into the growth potential of the aggregate economy since the growth rate of the economy governs the long-term investment environment, yet if technically speaking, the market is subject to the frenzy moment (scaring moment), then I will combine my own sentiment to evaluate the possibility of sell (buy), where my greed (fear) to pursue higher peak (lower dip) becomes the sell (buy) signal.

The stocks that I choose mainly have good track record in its financial statements. The procedure relies on the tools like data-mining. Regarding the prospect of the chosen stocks, I will examine those with economic advantages supporting its growth. I am not a sophisticated observer in financial statements and records. Therefore, I prefer economic reasoning to perform forecasting.

You may say, it is little bit like a cheap talk as implementation would be difficult. It finally depends on one's confidence (i.e. the above paragraph is one of my tactic). If I feel ambiguous on the macroeconomic environement and I feel entangled, I would simply prefer the asset management approach i.e. the proportion of cash and portfolio is well-scrutinized without any stakes or feel of "gambling" at the height. Therefore, the market value hopefully can be smoothed.

* * *

Two articles from Luk sir advise us how we should equip ourselves with proper attitude in investment and living. I strongly recommend.

• First part and second part.

Trend of Chinese Stock Market III

- More competitive future

Besides the macroeconomic thought, one also needs to notice that year 2007 is a critical year for the fundamental strengths and growth potential of many firms in China. In 2006, the firms in China can perform well through the economic growth. However, since China has to open the market towards the foreign firms in 2007 according to the entry of WTO. This has the possibility to develop fierce competition. Moreover, Renminbi keeps on appreciating so that certain industries will lack competitiveness in export.

Some of the industries such as the consumption-based industry may face challenge from the foreign competitors although consumption ability of mainland Chinese increase. Besides, some of the industries like banking may face some uncertain pressure through the entry of international financial firms. One has to notice that the information technology and the efficiency of the banking service in China may not comply with the international standard. If elasticity of Chinese people on demand of banking service is large, people will rather choose other banks to try the new service, this can be detrimental to the profit margin of the local banks.

China also advocates the corporate social responsibility in order to align with the world's standard. Some of the industries such as petrochemical industries and electricity need to spend extra cost on the environmental protection. Despite this, it does not totally bring the worse news to the industries since merger and acquisition will become a means to relocate the resource and develop the economy of scale. Industries related to infrastructure and some raw materials are the least affected area as they provide a way to improve the productivity and comply with long-term Chinese economic development (supply side, which is beneficial to the aggregate production level).

- Current status

The current situation in China seems to be ignored as the focus now is switched to the international financial issues such as the carry-trade of Japanese Yen, and the delinquent subprime loan and weakened economy in US. Recently Hong Kong Economic Times published news about the over-crowded banks and overwhelming number of registration of financial products in China, revealing the rise of probability of the crisis on Chinese stock bubble. Perhaps I am a bit sensitive and worried by the figures, but I always believe that there is the law of financial gravity that Keynes' castle in the heaven will collapse. This is a natural law after the frenzy speculation.

As a result, we should notice the bombs around us. The first bomb is the deteriorated US economy. The second bomb is the abnormal side-effect of liquidity trap of Japanese economy. The third is the potential failure of Chinese stock market bubble. As the number of bombs increases comparing with last year, conservative asset management becomes the crux to pursue breakthrough in the financial market. It is somehow difficult to predict the very short-term trend as the volatility has been enlarged.

Finally, try to work hard on our own jobs, as this is the way to secure our investment return, either directly by real output, or indirectly by stock's wealth (firm's profit).

* * *

Just think of a possible scenario for Chinese stock bubble. We know that the accounting facilities for the equity trading heavily rely on the information technology. In China, the increasing number of transaction may also lever the operational risk similar to the case of NYSE on Feb 27, 2007. Interestingly, I heard that the Chinese securities do not have the paper form i.e. the certification. Instead, they will use the computer to record them (Need to confirm).

* * *

Regarding China's economic development and new tax policy, I agree some additional points mentioned by Mr Cho at Hong Kong Economic Journal on Mar 13, 2007. Despite the overheating stock market, the optimal way is to notice the investment in certain industries (described above) and manage the proportion of cash and equities well in current year.

Trend of Chinese Stock Market II

It may be hardly convincing by solely using the contrarian's aspect to say that there is crisis in Chinese stock market. Here I would like to think of the macroeconomic aspect and fundamental aspect in order to illustrate how the potential crisis would become.

- Philips curve - Failure of Policy

If one has studied the macroeconomics, you should remember a story about the relationship between the unemployment level and the inflation called Philips curve. It mentions that the relationship implies that the government can carry out policies by targeting the inflation rate in order to control the unemployment level. However, this is proved to be failure once the people have certain rational expectation on government's policy. In turn, the Philips curve shifts to a new one because of the change of expectation. Eventually, the policy becomes futile to cope with the problem.

This intuition can be applied to the Chinese stock market and government policies. Although China once decides to let the stock exchange be controlled by the market's invisible hand, Chinese authority still concerns the administrative controls on the bubble. It is just similar to the government's control on macroeconomic variables, like the Philips curve. The people will generally follow the dynamic of what the government will do, so that the people can gain as best as possible under government's control. It seems that the stock index is well-done to keep on a narrow range of fluctuation. However, those people perceiving this controlled dynamics will earn much money through this mechanics, and this attracts more people without investment knowledge to follow the seemingly arbitrage opportunity.

To the worst extent, the speculation will widespread throughout the public. On the demand side, the people will gain much wealth through the "paper value". In turn, this increases the aggregate consumption and investment. Therefore it increases the chance of inflation. On the supply side, the over-heating due to speculation may imply the lower-productivity of labor (it may be abstract), and moreover, the potential rise of excess investment will jeopardize the quality of economic growth.

Regarding the inequality within China, the rapid surge and fluctuation of the stock market is also detrimental to the objective of the central government since those people living in rural region cannot enjoy this wealth effect owing to poor technology and lack of entry capital. Consequently, all of the above notions will force the Chinese government to provide macroeconomic adjustment in order to curb the inflation, the overheated investment activities and the inequality enlargement. Consequently, it can destroy the bubble regime and the bubble is no longer persistent. The implication is that the government cannot be so easy to design a simple relationship without considering some side-effect through the expectation of ordinary people.

I have provided some relevant analysis in an article (Market swallowed the katamine (except our dread-stricken grandfather)) before. This topic is closely related to the application of game theoretical thought. Regarding the macroeconomics, the above scenario is one of the general results of political macroeconomics, where promise of government over periods of time is easy to be violated.

(Continue)

Trend of Chinese Stock Market I

Chinese stock market is a bit complicated to carry out the analysis since its capital market is controlled by the government. Despite the outperforming economy of China, the short-term trend of the stock market is still under the risk of collapse. It is not because of the Japanese Yen or US possible recession, but the recent hot topic on the bubble of Chinese stock market. It seems that this hot bubble has become the rotten bread, in which fewer people have concerned this issue in this month.

Fundamental status of the Chinese economy is indeed outperforming the world-wide market where companies in China indeed earn a lot of money through the benefit of recent economic growth. Someone said that the PE ratio of A-share stock market is still reasonable. Even though it cannot strike a new peak, it can sustain in the current high level.

Originally, the people who insist on this proposition are those researchers in mainland China. Later, some of the guru, including J. Rogers (He refused this statement first, and then accepted that Chinese stock market is still healthy) and recently G. Soros, who mentioned that Chinese economy would be "kept on an even keel"*, support that Chinese stock market will still be healthy in the coming year.

To my knowledge, it somehow leads to some thought of contrarian's aspect. Are the people too optimistic on the Chinese stock market? As for the guru, do they possess some interest so that they need to comment reluctantly?

(Continue)

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* From Article in Yahoo! finance Singapore - Soros blames yen carry trade for market turmoil-FT (An interview from Financial Times)

... Soros also said he thought the Chinese market would be kept "on an even keel" at least until after the Beijing Olympics next year. His comments were published in the newspaper on Friday. ... On China, noting that recent market events began there, Soros said the Chinese market had been rising at an unsustainable rate and the authorities had wanted to slow it down. "But, on the other hand, they don't want it to fall out of bed either so I think that you've had that sort of initial impulse and I think the Chinese market will be kept on an even keel, certainly until after the Olympics."

Trend of the stock markets in the open and developed economies - Mar 10, 2007

In some previous posts, I have pinpointed that the weakness of US economy would ignite the collapse of the stock market and have possibility to turn it from bull to bear. Having some reviews, we can see that Japanese currency is a kind of weapon on this issue such that when the US economy is weakened with uncertain trend in interest rate, the Japanese Yen will appreciate against the US dollar (In the other word, dollar depreciates), in which the various funds from all over the world will swiftly demand the Yen to return the loan originally used in the carry trade.

- Unstable US economy and spillover of liquidity

If there are more detrimental news on US economy, especially on the subprime loan, releasing out, the recent appreciation of the Japanese Yen will continue. When the exchange rate approaches to 114, there may be dangerous stop-loss trading mechanism which further deteriorates the global stock market.

Commentators always say that Japan usually has the cheapest loan in the international financial market since it has the lowest interest rate. What is the reason behind? From various analysts' comments, the cause of the abnormal development is due to the recession from 2000 to 2002 in the worldwide economy. In that period, US, Japan, and Hong Kong have suffered in recession, where the increase in liquidity, i.e. decrease of interest rate, is sufficient to support the economy and the stock market.

Most of the Asian-pacific economy have been recovered since 2003. As for Japan, its painful ten-year recession has not been recovered until last year, so that the interest rate is still low for Japan. Moreover, its prolonged recession has created the so-called liquidity trap. This creates the abnormal structure we can observe nowadays i.e. the interest rate differential. The extra liquidity provided by Japan has been flooded among the nations because of its alluring low interest rate.

The abnormal structure makes the reversal pattern become more vigorous. Thus when we consider the global open economy, we have the following update.

- The US economy should be possibly deteriorated in the future few months as discussed in the previous post. For the intensity, the concern is how the seclusion of the subprime mortgage market and housing market is, so that the other industries are not affected by this severely.

- The risk level for the fundamental economy has been leveraged in recent months since the Japanese currency has been in a relatively low level. Someone contend that the short-term adjustment trend has been finished, yet it is not certain if the volatility increases in the near future, as the international funds continue the same dynamic of carry-trade among the open economies. One should know that the interest rate of Japanese Yen is still very low.

- How is the adjustment speed? Fortunately US flexible exchange rate can be adjusted at the current period. Therefore, we can see the latest release of current deficit reduce. I think that US economy may have medium-term recovery through this mechanism, given that there is no more military expense on Iraq, Iran or North Korea. How long is the stagnated period or the recession? Someone suggest it may go to the period before the US presidental election, i.e. early 2008 so that the expectation among people would be changed.

If we want to invest in the global market including US, Japan or even Europe*, either the short-term game or the long-term game will not be easy. Therefore, mostly we would like to see the prospect of the emerging market, especially China. Of course, it is risky, but its reward is more proportional than what I mentioned above. I would like to comment the Chinese economy and stock market later.

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* Europe currently has relatively good economy under the government's policy on flexible labor market, yet as the US economy is still the engine for the world, it still brings some uncertainties to the Europe's economy. Notice that the economic growth rate in these developed economy has been slowed down.

Inefficient market as an emergency exit

There are some circumstances where an investor can acquire short period of time to sell his stock before the sudden collapse. Today, I also discovered this kind of opportunity for the traders to sell his stocks within 10 minutes. To use some economic jargons, it is an example of asymmetric information, which destroys the assumption stated by the efficient market hypothesis. It is supposed that most people with major in economics and finance know this hypothesis, and mostly, they can realize that there should be some discrepancies with the reality as the EMH does not work well in the actual financial market.

The representatives hardly obtaining the latest information are labeled as herd, who are also used to following other people's action as a feasible resort in investment and speculation. That's why the noise traders, knowing the techniques to dig out the patterns, can exploit the rent (extra profit) from the herds.

Here I would like to share my previous experience and today's observation.

- Penny's "shock" after the result announcement

Once I bought Hong Kong Economic Time, a penny stock, in last year. Originally I treated it as the investment since its business is observable and its financial performance is steady throughout the years. This firm can align with the development trend of Hong Kong as a financial center. The only uncertain thing is, its industry is over-competitive as entrants can easily grab the market share (e.g. the free newspaper distributed in the MTR and the estates). At that time, I felt that it has some characteristic financial products and advertising business which can quarantine itself from the fierce competition.

I bought this stock after the final result of 2005, and then possessed this stock until the interim result of 2006. In the afternoon, the company announced the result in the HKEX, while the other mass media, including various financial websites still did not release the news. I found that the EPS of the company declined comparing with the same period of 2005. Feeling a bit disappointed, I would like to release the stock in the afternoon trading section.

At that moment, there were still number of buyers from the small scale financial firms waiting for the purchase. The price did not change a lot. I immediately sold the stock within 10 minutes after the opening of the trading section. Afterward, the stock price collapsed for 9%.

I agree that there should be certain luck, but it is vital that there exists the herds who cannot perceive the information at once.

- Today's emergency exit

Today it seems that the stock price rebounded with sufficient momentum, yet when we look up the exchange rate of Hong Kong dollar against US dollar and the HIBOR rate (announced in the news in noon), it shows the pattern that there was capital flow from Hong Kong dollar to the US dollar. As for Japanese yen, it shows sudden appreciation in the afternoon. After this observation, I got the signal that there may be reversal pattern in the afternoon, and told my mother to sell some of her stocks. In the first 10 minutes, there was still enough time to evacuate.

This experience told me that the time-lag was still persistent after the signal releases. To find the reason why there is still opportunity to evacuate in this age, I speculate that the herds again show its powerful instinct to follow the popular commentators to purchase stocks. Moreover, in terms of knowledge, the reason to produce the reversal pattern is somewhat difficult to be interpreted. The herds are used to having less education in economics and investment.

From my experience, this kind of inefficiency is more significant in the intra-day trade as information needs certain time to be analyzed. To conclude, I would like to say, everyone in the stock market are participating in the information race. Not only do we need to work hard to seek for hidden information, but we still need to research and adapt to the latest information technology in order to enhance the speed and expand the information set. Try not to be the herds!

- The cruelty is, we need prey to survive

As I said investment and speculation are somwhat like a race, we need to know that unless you want to join with some agents in order to maximize the information processing efficiency through the comparative advantage, we need to combat some other opponents. It is cruel, but this is what market forces agents to do, to survive. Most commonly, we need to figure out the herds as prey. How can we focus on the herds in the population? Just leave this in the future essay.

An example of why a country gets poor

Today the stock market vomitted again, as HSI had a distinct drop by 777 to 18664.88. It has matched most people's expectation. Originally I decide to write an essay concerning the stock-picking by noticing some intuitive characteristics. However, I suddenly noticed somewhat funny but miserable news. Let me post the link and a brief outline.

http://news.bbc.co.uk/2/hi/africa/6390319.stm

Gambia's UN envoy 'is expelled' Gambia is reported to have expelled a UN envoy after comments she made about the president's HIV/Aids cure claims.

Yahya Jammeh said his herbal medicine, taken orally and applied to the skin, cures the disease in three days.

Fadzai Gwaradzimba warned that this treatment could encourage people to engage in risky behaviour, believing that they were cured of the disease.

The United Nations could not confirm she had been expelled, but says it backs her comments over Mr Jammeh's claims.

Gambia's Daily Observer newspaper said Ms Gwaradzimba "has been given her marching orders because of irresponsible behaviour".

This is why a country is getting poor by repeating its mistake. Most of the African countries were granted with capital to develop its infrastructure and education. This kind of grant can be waived as soon as this is deemed to have improvement. Yet, the countries still have far way to go. Not to mention the infrastructure, the education level of the people is rather low that it is impossible to carry out effective policy to alleviate the poverty. After equipping the infrastructure and assistance of human capital from foreign aid, the corrupting government and practices make the sustainable development become vulnerable.

China originally resembled the African countries in 1970s. After series of economic reform by Deng Xiaoping in 1980s and 1990s, it enacts the first successful transition of economy from the poor to the prospect. The recent meeting of People's Congress reveals that the economic growth is not the most important concern. However, several fundamental measures in education, environment protection and property right have to be carried out intensively. These show the further transition of Chinese society and economy from the speedy path to the sustainable path.

If the world is perfectly economical in thinking, the solution is, to treat the outrageous irresponsibility as bankruptcy and carry out takeover action. Nevertheless, it is certainly the prejudice and lack of humanity.

Mixed Anecdotes on Mar 2

- Sell substantial amount of shares

There is already two consecutive days that the stock price declined. Yesterday the Dow still cannot make a beautiful outlook. As I have the belief on the revealed worsened US economy, I decided to sell substantial amount of share and hold more cash. In the morning, I sold the stocks equal to 25% of my portfolio (including my cash, which initially accounts for 40%). Fortunately as expected, the plowback really happened today and the early morning became the emergency door for my evacuation.

In the afternoon, the situation was exacerbated. The plowback no longer appeared. The more drastic and dreadful incidence occurred since the penny stocks started to collapse in the whole afternoon. Luckily, I did not follow some people in some forums or newsgroups before. That's really important to remember the investment and speculation principles proposed by some experienced businessman written in the blog (I have posted the relevant links). Moreover, some important knowledge is etched in my mind.

• Try to distinguish investment from the speculation.
• Plowback is important as cut-loss. Do not deal with patients in the psychiatric hospital.
• I acquire certain philosophy throughout January and February. Greed eventually leads to loss. If I feel the sin because of greed and pride, it is the time to sell stocks to realize the profit. If one grasps that kind of content, then one should probably grasp most wealth objectively.

- Greenspan and Jim Rogers

Please notice that Greenspan has once warned that US economy has entered the recession and ridiculously he refuted his previous opinion and supported that US is still "OK". His action gave people a kind impression, to prevent himself from the scapegoat (as suggested by a member in the forum). From my point of view, his action may cause self-fulfilling prophecy, which is much more disastrous than his original expectation. Thus, he decided to re-explain his calm message.

On the other hand, Jim Rogers, another investment guru, warned that China has developed the unhealthy bubble in the A-share market. Once he also changed his opinion that Chinese stock market was still "OK". Did one still remember these anecdotes? From the Hong Kong Economic Times, it mentioned that Rogers was also vigilant on the US economy. He also said that US economy may enter the recession. As an investment guru with university major in history, one should not have any contempt for his vital opinion.

- Slowed down information technology and network system

You may notice that the trades in recent weeks were a bit slow. Someone said that some investment companies did not allow the customers to trade the warrants. Luckily, it confirmed that it was just the rumor. Anyway, regarding the collapse of US stock market on Feb 28, we have to notice that the operation risk through the information technology should not be ignored. We were still exposed to this kind of risk. If we were not doing well in this kind of risk management, it is potentially the bomb for the global economy under the anxiety and the self-fulfilling prophecy, comparable to the Y2k advocated before year 2000.

- Still a long way to go...

Just observe from a newsgroup that there is significant number of people contending to hold the penny stocks. Until now, they still cannot realize what exactly the era has been changed. This may provide certain signals that the downward trend is not so easy to end. Moreover, this also reflects certain philosophy in trading and investment. Don't penetrate into the group. Otherwise there may be severe peer influence. To learn how to escape from the excitement and peer is one of the main key to succeed.