A conclusion for April 2007

- A summary and my persistence

Finally April comes to the end, and we find that April is not as disappointing as those records shown before. Although Hong Kong's HSI and HSCE cannot strike for a new high, the stock indices in most countries continue to show its bullish strength. At the end of April, Shanghai A-share even successfully reaches 4000 points after the announcement of increasing reserve ratio. We all notice that Chinese investors seem to ignore the effect of the monetary policy or various policies.

As for my prediction, it seems that the sharp plunge "succeeds" if one merely matches the only sharp drop to check my prediction performance. How is my comment recently? I think that it is no use talking much now. What I do is the same as before. A-share is technically unstable but relatively bullish in the long term. You may check my comments or reasoning written in this month. Since Hong Kong's short-term trend is now susceptible to trend in Chinese stock market, it is somehow embarrassing to reach such an inconclusive level, in which PE is acceptable, but the sentiment (in China) is not acceptable.

- Sentiment

Considering my sentiment, recently I improve my habit not to glance at the stock price frequently and keep myself from watching the stock price more than once. It is probably due to the busy workloads in April, constraining me not to focus on the instant prices, thus I did not do frequent trades even if I noticed that there may be change in trend. To certain extent, my mindset is to do buy-and-hold strategy, as I have faced the punishment of seemingly well-done trades from January to March. Moreover, it is valuable to improve my investment principle in two complementary aspects - 1. violate the normal sentiment and 2. believe the facts and the comprehensive logical derivation.

- Why do I use English?

There are some people asking me why I insist on using English to write the blog. The reason is, on the one hand, I believe English is the truly useful language in an international city. Practicing English is necessary to maintain the competitiveness, especially for a student or junior level worker. On the other hand, if I write my blog in Chinese and talk about things related to the investment, it may be attractive, but it violates some principle in seclusion and I don't intend to provide public good or externality. Writing in English is a way to lever the cost of reading, which can balance the trade-off in recording the practices, seeking advices, and spread of externality and public good. Furthermore, currently I have a few foreign friends. Although I haven't disclosed my blog site to them, it is possible to let them read my comments conveniently in the future, thus English should be the prevailed medium.

Finally, I actually don't care if my points will be focused by other people. Conversely, I am afraid if my points are focused by other. What I emphasize here is to record my thoughts and logics so as to be convenient in managing the analyses continuously and systematically.

Bubble economy revisit V

I have posted the red asterisk (*) to indicate that there is important additional comments on some issues. The first issue is regarding the Japanese asset price bubble. It should not be triggered by any bank run. The second one is the comments augmented in bubble economy revisit IV, which asks the question about China's situation. In order to enhance the cohesion of the content, I do not open a new essay to further discuss this. You may go back to have a check.

- Bubble economy II
- Bubble economy IV

In conclusion, the bubble is formed by the following pattern*.

1. Extreme unconventional behavior in the economy

a Leads to self-fulfilling prophecy (i.e. expectation driven economy) - Part I

a Economy or asset market performs well because of the self-fulfilling prophecy - Part I

(expectation to have much wealth in the future, or some people buy one's asset).

2. Foundation of economic recession

a. Loose money supply control/loose credit approval/flood of liquidity - Part II

b. To some extent, the widespread of the derivative's trade enlarges fluctuation - Part III

c. Shirking labors and idle capitals during the speculative and frenzy environment (more abstract) - Part II

a Strengthen the potential severity of the asset bubble, and jeopardize the economic growth. - Part II

3. Some ignition or stimulation such as

a. Bank run - Part II

b. Capital flight - Part II

c. Evacuation of the speculative funds - Part III

(With large scale trades in derivatives/Leverage products)

d. Disappointing result announcement (Series of results) - Part IV

a Trigger the sell-off and collapse in the asset market through the self-fulfilling prophecy

(expectation to be poorer in the future, or dare not buy the other's assets).

Usually, thanks to the self-fulfilling prophecy, we can observe that before the burst of the bubble, there is high inflation, while after the burst, there will be deflation. After people's action caused by the self-fulfilling prophecy, the economy may have chance to switch back to normal by restructuring in either preference, knowledge or policies. The new wave of theme, challenge and discovery (such as boom of internet) will then come to the economy to create another regime of self-fulfilling prophecy. This creates different cycles of economic bubbles with various periods.

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* Currently there are a few "feedbacks" on the points to compensate some weakness in the logic, causing much inconvenience in reading. This conclusion is similar to my previous parts of the analysis although there is some confusion on the categories. Currently I feel comfortable to have such a conclusion. I hope that it is possible to reorganize this series in the future.

Bubble economy revisit IV

- Consecutive disappointing result announcements

for the "conceptual" industries during the bubble

This kind of ignition is very common in different stock markets in all over the world. The recent representatives are the Hong Kong red-chip bubble in 1997, and the worldwide dotcom bubble in 2000. The time for the ignition is around the result annoucements for the "conceptual firms", in which they usually have unsustainably high PE ratio. From my point of view, the burst should be attributed to the cluster of several announcements on the failure of their businesses, either unexpected low profit or deficit, or incredibly high debts and detrimental policies on the shareholders.

Obviously, this kind of ignition aligns with the law of causality. The firms have its price increase owing to its concept on a new business. It gradually turns into the scenario that is high PE and PB ratio. In another word, they heavily derail from the fundamental quality. Usually, the companies only own the concepts without the concrete business models. Their "easy" fund cannot add value on the companies while the stock prices are frenzily high during the bubble period through the self-fulfilling prophecy. During the result announcements, all adverse consequences appear around that time and eventually force the sell-off.

As for the severity of the burst, it depends on the scale of the bubble since the enlargement of the bubble implies more disparity between the fact and the expectation. It also depends on whether the frenzy investment has widespread throughout the people, or heavily equipped with leverage products mentioned in the previous points, as the small amount of people and the lack of the leverage product cannot create severe wealth decline. Accompanying these factors, this can create the destruction that we can see during the red-chip bubble and Dotcom bubble.

Comparing with the bank run, currency attack, and evacuation of the speculative funds, I would say that this kind of ignition is rather less instantly destructive. If there is solely this factor acting on the bubble without the leverage investment or lending, this may only lead to sharp drop on that "conceptual" sector without conspicuous adjustment on the whole market. In turn, it may only lead to slow decay, or continuing pattern on the whole market trend. This comes to another point that interaction among the ignition factors is controversial.

One may ask that in the case like China, where recently there are heavy controls on the capital flow in the asset markets, it can succeed to alleviate the pressure on the bubble with the assistance of the macroeconomic policy. Given that every measure and control are perfect, does it imply that it is possible to maintain the bubble at the significant height? The answer is no*.

(Continue)

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* Added on Apr 28, 2007: Why is it no? From my point of view, if it is truly successful to strictly control the credit and money supply in the economy. The economy will adjust through the higher interest rate (or higher stricter credit approval) and dampen the consumption and investment, and affect the corporate profit even though the wealth effect is initially strong. I believe that there should be trade-off that the monetary policy should not be compatible to the bubble economy. The conspicuousness of this trade-off depends on the time-lag of the monetary policy, the strength of the monetary policy and the change of the expectation on the people (similar to the policy failure).

As for China, to my knowledge, in addition to the congenital nature of the time-lag, I think that the overall strength of the monetary policy in China is not strong enough. Moreover, the people are generally not sensitive to the monetary policy so that they continue to believe the expectation of the castle on the heaven. Jointly speaking, the monetary policy seems not to have the coordination between the government and the people. Firstly, the people originally own excess amount of cash. Secondly, even though China has already calibrated the interest rate and the reserve ratio, the bank or lower hierarchy still continues to endorse the loans through the bilateral agreement (properties) so as to create the excess liquidity.

I hope that China can successfully control its liquidity through reasonable coordination, expectation and information flow, thus the smaller the bubble is, the lesser the severity of the burst is.

Bubble economy revisit III

- Setback of various speculative funds - currency and derivatives

To certain extent, this kind of ignition is similar to the bank run, yet the focus and the responsibility are on the fund managers. For example, the recent carry trade in Japanese Yen enabled the investors to borrow large amount of fund and invest in various financial products in everywhere. As for the hedge fund, they may be attracted to the bullish stock market and try to invest in the derivatives so as to lever their returns on their portfolio.

To earn the segment of profit in the overheating market is easy, so is to lose in this overheated market. Once, there is slight fluctuation caused by some miscellaneous exogenous shocks. This will cause the stop-loss mechanism so that the funds will desperately reduce their open interest in their derivatives. The patterns similar to the stock crash in 1987 may happen. As nowadays there are lots of hedge funds and private equity funds looking for opportunity in the worldwide financial market, this kind of shocks can be globalized as soon as the financial markets are open enough.

In terms of the power of the devastation, according to the historical record, it is strong in the short term as an impulse, for example, stock crash in 1987 and recent pseudo stock crash on Feb 27, 2007, yet the response on the stock market may not be that long-term, as soon as there is no further bad news accompanying this shocks. Some people contend that there could be strong devastating effect on the global economy when the Long Term Capital Management, a renowned hedge fund found in 1994, suffered seriously during the time when Russian Bond was default. Fortunately, the US government (the FED) organized its business by establishing various agreements on its debt restructuring so that the crisis of a severe economic decline is eliminated.

- Discussion on Bank run and speculative funds

One may ask why the bank run is much more serious than the ignition I mentioned above as the banks and the above financial institutions are actually similar, i.e. making the leverage on their investment. The above analysis is based on the historical background that we can observe. I think that it depends on whether the financial institutions have huge number of stakeholders. The bank is crucial to all different kinds of investors.

Once, when the bank has the problem, this easily creates the chain effect to the whole economy. As for the hedge funds or various investment funds, in the past, it served the specific segment of customers who were risk-loving. Even if normal customers involved in the hedge fund, this should not seriously affect their whole portfolio, thus the devastation may be smaller in the past. However, the trend of the financial market changes sharply from the traditional banks to the financial innovations. It can create the uncertainty for the future shocks.

From the above analyses, these arouse some additional points for bank run and speculative funds as follows.

- After the previous stock crashes and several economic recession, we recognize that the risk management concept is particular important nowadays. When the financial institutions did well in the risk management practices, basically they can reduce the severe chain effect on the economy.

- Although the original purpose of financial innovations on the derivative products is to create the useful tools in financial risk management, they can be the dangerous weapons to cause drastic decline in the economy if they are widely used in the whole economy.

- International diversification can mitigate the risk of failure of the financial institutions in the local if the bank run or serious failures of funds occur. In turn, this can reduce the chance of sharp economic decline in the local. Nevertheless, the weakness of this company may also affect the economy of the foreign countries through the international trade and finance. Thus, there is something called as risk-sharing happening in the international coordination.

I am optimistic on the development of the financial market such that the global economic recession should not happen so easily, since the general risk management techniques are developed to be more and more sophisticated while the international diversification proceeds well. From now on, the volatility should be the main concern.

(Continue)

Bubble economy revisit II

In the previous part, I mentioned the importance of self-fulfilling prophecy and foundation of economic recession. Here I would like to state some ignition which are usually the sudden causes (except the discovery of hyperinflation) turning the economy upside down.

Note that these ignition are mostly the layout by the foundation of the economic recession. A concrete and simplified example is that the people are lazy or frenzy in speculation through the expectation on the surge of asset price (self-fulfilling prophecy) and become lazy to work and improve themselves (foundation of economic recession). A small incidence, let's say, some "illness" due to lack of exercise, causes them to get back the money to see the doctors, which in turn devastates the economy.

Sometimes, these sudden ignition may be attributed to some exogenous shocks, such as shocks on resource price and disease. However, these causes are somehow the random shocks without the previous endogenous reasons to create them. Here I would emphasize on those ignition from the foundation of the economic recession.

- Bank run and capital flight - a usual example

This must be one of the classical example on the fall of an overheated economy. The formation of this kind of failure is because the bad debts among the financial institutions are unsustainable or there are too many loans with low quality. Usually, during the peak of the bull market, the banks are less vigilant in the approval of loans so as to enlarge their businesses*. The frenzy bullish market is sometimes regarded as the example of prisoner dilemma, while the loose approval of loans is also another inevitable phenomenon owing to the prisoner dilemma when the economy lacks supervision to the financial institutions.

The microscopic example is the bank run while it may affect the other banks or other industries also. The bank run indicates that the financial institution starts to suffer the problem in credit. Amid the frenzy regime, this makes people become anxious and creates the domino effect to push down the bull market. Once, this happened in Hong Kong in 1960s and Japan in early 1990s*. This incidence ended the frenzy Japanese bullish asset market formed in late 1980s. It nearly occurs recently in US in this year, yet the rational stock participants in US (less chance to have the self-fulfilling prophecy), the strength of other industries and the seclusion of the bad debt deter the domino effect from pushing down the economy further*.

If the government and the central banks also heavily assist these banks to approve the loans with low quality together with weakened foreign reserve, it will be easy to have financial crisis where the international speculators will attack the currency of that countries so that there will be so-called the capital flight. Once, this happened in many developing countries such as Thailand and South American countries in 1990s.

Whenever the financial crisis or bank run take place, the banks or central banks need to raise their interest rate so as to attract the capital back to the circulation, or prevent the further attacks by the short seller, or increase the risk premium of the credit. For the fixed exchange rate regime, the effect will be more severe since it has to raise its interest rate much more in order to maintain its currency. For the floating or mixed exchange rate regimes, the country has the choice not to increase the interest rate, while conspicuous depreciation will take place. Consequently, to different extent, this leads to lower consumption and investment and thus hurts the corporate profit and the employment status of the whole economy. Therefore, the bear market will take place after this.

As for the duration, the experience shows that floating exchange rate regime has shorter duration on economic recession since depreciation facilitates its export. It also depends on the structure of the economy itself. This kind of ignition is common in the developing countries when their currencies and system is not well-supported. The effect on the economy is also large, especially for those economies with open financial accounts.

(Continue)

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* Currently the objective economic data show that US economy is still healthy, yet discreet measures are still needed to assess whether it succeeds to get rid of the turmoil of the crisis of the subprime mortgage loan.

* Added on Apr 28, 2007 - Errata: I just confirm that in early 1990s, Japan did not have any conspicuous bank run, even though the quality of the loans was deteriorated after the real estate price bubble. Japanese asset price bubble burst is triggered by the lack of competitiveness for the companies during the Japanese Yen appreciation, with the over-expansion on the credit. After checking the information, I find that bubble attributed to the bank run is rather rare nowadays. The true bubble bursts triggered by the bank run include the Tulip manias in 1630s, South Sea bubble in 1710s, French Mississippi Company in 1710s, post Napoleonic recession in 1815-1830, and the Great Depression in 1930s.

Nevertheless, I should also emphasize that before the bank run and capital flight, it is mostly the loose credit, or the expansion of the liquidity and money supply, together with the derivatives and different speculative activities discussed in part III, to catalyze the burst of the economic bubble (you may regard this as the foundation for the economic recession). Nowadays, most of the bubble are triggered by the disappointment on the business performance, thus after this discovery, people follows the self-fulfilling prophecy to execute the series of sell-off in both the stock market or real estate market (See part IV).

Bubble economy revisit I

(This essay is my thought on an economic phenomenon - bubble economy. It is not necessarily specific to China only. However, I hope it can give us insight on Chinese situation.)

In the final stage of the bull market, it frequently has the news concerning whether the stock market has reached the bubble. After the bubble burst, it would reach the bear market. In my previous essays such as Asset market in China II and IV, it has covered the possibility of the change in trend in terms of economic situation and self-fulfilling prophecy. Consequently, depending on the severity, it can be the adjustment of the upward trend or the bear market trend.

Studying the fall of the stock market bubble in 1970s, 1980s and 1990s, we can often see that self-fulfilling prophecy would come together with the economic structural change. For example, in 1970s, Hong Kong stock market reached the bubble situation and bursted because of the incidence on fake stock certificate and the controversial oil price shock in 1970s. On the other hand, in 1980s, Japanese asset price bubble bursted because of the failure of the banking system. At the same moment, the economy in US had a short period of recession, yet it was not that prominent. Thinking of the true causal relationship between these, I would feel a bit complicated. Nevertheless, I have the following thoughts on the formation of recession through the collapse of a bubble*.

Regarding the collapse of the bubble, it is worthwhile to notice that when the economy reaches the distorted situation, such as strong externality on capital or labor (If I invest in the capital or work, it equals that the others have already invested in that capital or worked, thus the thrust on capital investment and labor work is failed), or extreme labor's wealth effect (labors are lazy to work regardless of the incentives), these foster both the force of the expectation, i.e. self-fulfilling prophecy, and the foundation of economic recession at the same time.

Under this situation, I would say that self-fulfilling prophecy will switch the economy to the unstable and uncontrollable state, and then there is "activation energy", or called as ignition from the foundation of the economic recession so as to cause the remarkable decline. It resembles an example that a guy was so hungry that he put the egg inside the microwave oven for convenience, without noticing that the egg turns to the unstable state after cooking in this way. Even a mild touch on this cooked egg by that hungry guy will ignite the "egg explosion" and finally hurt himself.

What is the possible activation energy in order to burst the bubble?

(Continue)

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*It is not always the case that the bubble comes before the recession. For example, the wrong-doing (e.g. heavy debt) of an immature government (e.g. Mexico in 1994 and Argentina in 2001) can lead to failure of the economy without the formation of asset or economic bubble.

Displacement and velocity

(I just finish one more essay for the people with science or mathematics background before my presentation takes place on Friday. To certain extent, the natural science can be applied to the investment or trading through some concrete images.)

I remember when I absorbed the knowledge regarding physics and mathematics, it considers the displacement and velocity frequently whenever it is related to mechanics. Here, involved in the stock market, I feel that these two concepts are still very crucial. From my own point of view, the price level can be regarded as the displacement, while the rate of change of the price can be regarded as the velocity. Here I would like to elaborate more about these concepts in the trading and investment practices.

- Displacement (level) is important to the value investment

To be a value investor, one should acknowledge that they should buy something cheap. Therefore, lower price level should be particularly important for this group of investors. They can invest regardless of any momentum or impetus. When they think that it is overvalued, it is the time to sell the stocks. All the concepts are just to assess the displacement (price level/PE level). Therefore, if one is used to making value investment, he or she does not use any technical analysis as the tools. In the most traditional aspect originated from Graham, he or she will use the PE ratio only to evaluate whether the stock is cheap or not.

- Velocity (rate of change/momentum/technical analysis) is used in short-term trading

On the other extreme, the short-term traders would rather choose the velocity. By assessing the potential momentum in the future through the price series and turnover, they can get the signal whether the stock price will have the big jump. Here, they will not regard the price level. Instead, they are based on the impetus and grasp the profit during the strengthened momentum. They think that the price level and PE ratio let you miss the chance of surge.

- Conclusion

These two kinds of concepts can be mixed together. For example, the growth investment proposed by Peter Lynch is a kind of mixture of these through the PEG ratio. Yet, the investors or traders should know what they are doing. Most frequently, most traders will buy a stock because of its strengthened impetus, but they set a ridiculously high price as target price. If fundamentally, their stocks are not performed well and the momentum loses after the trend of the speculation, they will suffer severe loss. Therefore, to realize whether you are aiming at the velocity or displacement, or how they are mixed is a controversial rule for the ordinary investors or traders. It aligns with Mr. Luk's thought on my speculator's mindset and my investor's mindset.

Updated comments on US and Chinese economy on Apr 17, 2007

Recently I am too busy to follow up several presentations and reports. Originally I would like to devise a conclusion for my previous analyses in Chinese economy and asset market with certain pictures or graphs to provide some concrete supports. Moreover, I have already designed certain topics for the future use. But eventually, I could not spend much time to type lots of analyses here. I expect that under the current busy status, I would mostly express my views or describe the views on the others by using the format of notes or anecdotes. Here, I update my previous comments on both the Chinese and US stock market and economy.

- Regarding the current status of Chinese side

Currently I would not amend my previous speculation on Chinese economy and stock market in both the short-term and the long-term. For the fundamental economy, its base is fine except that asset-value-driven market makes it unstable and unhealthy. Forced by the potential government's policy on developments and seasonal adjustment after the result announcements, the short-term adjustment should come.

However, discounting the effect of the expectation on Chinese government policy, we can see that the adjustment may be smaller than what we expect. Furthermore, provided that other things are constant, the duration for the adjustment may be shorter as if we have seen in March, since nearly all people reflect their preference on the future direction.

Currently, I just wait for one or two weeks to see whether my speculation before is correct.

- Regarding US's economy

This is an external factor affecting the world economy. I would say that it is better than what I expected in February. My bear mindset in US economy is also diminished. Current data shows that US's consumption can keep persistent growth. The demand side does not drop (and even rise) even if the potential restriction on lending by the financial institutions may reduce consumption and investment. The supply side or productivity does not drop that much (and even increase). Perhaps the proportion contributed by the IT industries, and then the general industries except financial institutions can generate the strong growth. This successfully deters the widespread of the subprime loan crisis.

Despite this, the interest rate will still be an uncertain issue. Stability of US interest rate is the main concern. Moreover, the time lag of the effect of the subprime loan may not come at this moment. Therefore, further discretion should be made when we assess US's economy. Currently US stock market performs well by the thrust from merger and acquisition and its outperforming economic data as discussed above.

- Chinese economy affected by the US economy

Will China be much better-off through the current status of US economy? From my point of view, Chinese economy depends crucially on the exchange rate and quantity of export to the US. When the US dollar against RMB, affected by the expected US's interest rate, keeps low, it can slowly dampen the Chinese export sectors (especially on the industries without comparative advantage). Yet, Chinese expansion on the local demand will be dominant in the next few years through the local wealth effect and development policies, thus the growth of the Chinese economy should be sustainable and less dependent of the US's economy than before.

There are too many exogenous shocks and variables, including the oil price and the conflict in international trade, affecting any verbal forecast. Yet, I will still set the medium and long term direction based on the above ideas.

* * *

Further comments from Mr. Lam in e-channel finance (not official translation) at RTHK:

1) US economy does not have any problems regarding the subprime mortgage loan with the reason similar to mine described above.

2) Chinese stock market does not have problems, since it has plunged seriously before so that it is normal to have a conspicuous technical surge. Furthermore, the Chinese leaders have acquired much techniques in controlling the economy by realizing the history in US in 1930s, Hong Kong in 1970s and Japan in 1990s.

3) US economy can even be more stable since the other parts of the world can stabilize its economy through world trade and foreign direct investment.

I think his opinion is fruitful to compensate and support my thought on the economy.

Anecdotes on Apr 11, 2007

I just record today's news here.

- Central government intends to release the recently first macroeconomic policy on the development in order to crackdown those parts of the industries which consist of high content in fixed asset investment but low output level. This is firstly scheduled in the aluminum industry. As I noticed, it mentions that more conferences will be held on next week so as to interpret the further policies (read from finance.qq.com).

- A few days ago, there has been news concerning the date of release of the future in the A-share stock market.

Most monetary policies, including the open market operation and reserve rate, have time lag in order to see the improvement of the overheating problem. Now that the data continues to show that the lending and CPI surge impulsively, while the fixed asset investment may have the potential to dash again. Needless to say, the stock market in China has surged memorylessly. As mentioned by Tao Dong from Credit Suisse in the interview by Money Times, he expects that the macroeconomic policy may carry out in second quarter.

Central government tends to change its style from the passive to the active action. Perhaps this action is the forward-looking measure. Somehow, it is faster than what many have expected.

Finally, the A-share stock market has been overheated so that I guess it should be vulnerable to response the detrimental news. The above two news may be the cause to end the impulsive surge recently. I have updated my own technical index that Shanghai A-share has nearly reached the previous high in terms of difference between the stock index and 250-day MA. As for another oscillator, it has been very close to the threshold level I frequently mentioned before. Although the impetus mentioned before is still present, it is not sensible to buy any stocks now to balance the trade-off of return and risk. Let's observe this carefully. Buying IPO is usually the most preferable alternative under the current situation.

Anecdotes on Apr 9, 2007

Originally I decided to buy stocks in April. Finally I purchased two stocks in small amount. I don't want to rush in the market as I feel risk-averse in my psychological sense. Recently I realize that the truly busy period is in April and May. Let me try to allocate the time well in order to finish both side of works.

Regarding the Shanghai A-share, the assistance of my technical analysis shows me that there are only a few steps to reach the threshold level. So far, the Shanghai A-share did "well". I guess that there are also one or two weeks that Shanghai A-share will dash upward impulsively. After this, I guess there would be a sharp drop, but now it is still uncertain whether this adjustment will be longer than that in January. One hint we can see is that the potential index future market may matter (in terms of volatility and level of adjustment).

Both the fiscal policy and monetary policy become futile at this moment. It is deemed to be the policy failure and irregular nature in the economy (such as strange preference and externality) of China. Yet, unless US has adverse shock, I am confident that adjustment in the form of sharp drop or even stock crash, instead of bear market, will take place afterward. In a mature market, recession accompanies bear market. In China, the convergence of bear market and recession is in progress owing to many arrangements to liberalize Chinese financial market in the expected future, thus the chance to have the bear market like the one in early 2000s is little*.

From my point of view, technical analysis is pseudo-science, which is somewhat paradoxical in forecasting. It is not healthy to totally rely on it. In this period, with its assistance, I would aim at controlling the proportion of cash and stock so as to balance the return and risk. The practice and application of objectivity and independence are crucial.

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* The risk of recession in China is smaller as analyzed in the characteristics under Asset market in China - perspective in April. This paragraph is an additional point for the alignment of the stock market and the economy of China.

Asset market in China - perspective in April V

- Characteristic 6: Path to modern asset market

This is the final characteristic I want to share. It is not about the direction or periodicity of the Chinese stock prices, while it is about the change in the volatility. Don't look down on the volatility, since it can reflect the strength and the stage of a financial market.

Regardless of the past, I expect the volatility for the Chinese stock market will consist of generally three stages. The first stage as we can notice is the age with upward bias since there is liquidity thrust putting the price of the asset to be higher. One characteristic is that high autocorrelation should be the representation of the Chinese stock market in this stage. Volatility is, however, relatively stable thanks to the government intervention in both the macroeconomy and the stock market.

The second stage is the volatile age due to the derivative markets. From my point of view, this kind of situation may be persistent for 5-10 years before the establishment of a comprehensive financial market in China. In this age, this resembles the stock market in Hong Kong in the period from 1987 to 1998. Government would prefer using a good system instead of intervention so as to control the stability of the stock market. The derivatives and other financial products (thanks to the inventions of them in 20th century!) can become an endogenous force to control the biased level of the stock market. Nevertheless, the people who lack information and practice would contribute large fluctuation to the stock market.

The third stage is the unpredictable age, which resembles Hong Kong or New York one. In this era, the market will be more transparent and the information flow is more efficient. The financial market in this age is much more open and the people are more educated in investment and wealth management. This tends to be a more efficient market (Of course, even in Hong Kong and US, the argument on EMH still exists so that we cannot easily agree that EMH will achieve). After achieving this, Chinese stock market will have already been the world class.

My naive thought is, history would repeat itself in different countries although the technology is more advanced. This is thanks to human's sticky animal spirit and learning cycle. Perhaps the advanced technology would assist the evolution to become faster, yet the openness of the capital market also has to be faster in order to enable the capital market to evolve faster.

(Continue, Next part is the conclusion)

Asset market in China - perspective in April IV

- Characteristic 5: Adjustment or recession through the self-fulfilling prophecy, with continuation of growth

In this part, I would like to talk about how the chance of self-fulfilling prophecy would lead to adjustment or even recession for the Chinese economy. The nature of this is different from the decline of the business cycle as discussed in characteristic 2 and 3. It is because the self-fulfilling prophecy is somehow so-called as a cause of adjustment by some anxious expectation, even if the foundation of the economy is good at that moment. In the economic literatures, usually the cause of the self-fulfilling prophecy (indeterminacy) is owing to externality, imperfect market structure, inequality or unusual congenital preference.

Putting the literatures in the application, what cause of the self-fulfilling prophecy could we find so as to excite the market, or even ruin the market?

As mentioned in Trend of Chinese stock market II and Market swallowed katamine, I would like to emphasize on the seemingly useless policy in the long-run. This indicates that the people can no longer match the government's policy and follow the frenzy speculation. This may be the start to enable the economy to reach the overheated and unstable stage, where people have the alternative preference to imitate the other to consume and invest.

- Recall Japan's recession through asset price bubble

The economy will become unhealthy as soon as the people are more willing to buy or invest by using the expectation on others as proxy. Some irrelevant news not related to the economic nature can overthrow the frenzy economic environment through the stock market first, and then if the domino effect is strong enough, it can spread to the property market and good market through the wealth effect. Finally the most serious scenario is going to the labor market (unemployment and reduction of wage). If all the steps are done, then the economy is surely innocent to suffer in the recession.

It seems that the devastating consequence is exaggerated. Yet, it was almost the case for Japan in early 1990s, where under no financial attacks and capital flights, the economy of Japan turned into the down trend in the rest of 1990s. As for China, how is its possibility to develop such kind of scenario?

The capital market of China are still close so that there are still lots of discreet measures to allow the foreign capital investing in China. Moreover, the QFII only consists of a relatively small proportion of the overall security investment in China. It is difficult to have shocks on the economy owing to the evacuation of the foreign capital. Therefore, the probability to have the recession similar to Japan should be smaller*. How about the recession similar to Thailand in 1997 under the capital flight? It is even smaller as the foreign reserve in China is much larger than that of many developing countries in 1997. In conclusion, all of these make sure that China can have less chance to be involved in the turmoil of recession due to the self-fulfilling prophecy.

- What is the gun powder then?

From my point of view, the salient adjustment would take place under the self-fulfilling prophecy until the amount of gun powder is enough. What is the gun powder? It should be the number of small equity holders in China. In terms of investment knowledge, they are mostly used to adopting herd instinct. Concretely speaking, the truly frenzy moment accompanies certain characteristics as if most people no longer get the sources that China has strong economic growth through the news and analysis, but from the rumors or discussions. More crucial phenomena, such as over-crowded banks, flood of shirking labors due to speculation, over-optimistic and emotional slogans or titles posted in the articles, need to be scrutinized carefully.

As soon as the penetration of equity holders in China enhances the effect of wealth, there may be some chance that the economy will also be affected severely. Therefore, either going to adjustment or suffering in recession hinges on Chinese government by attempting to crack-down the frenzy speculation by various aspects. One has to notice every actions and progress (successful or failed) on the policies on the stock market.

(Continue)

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* Chinese economy is also having the reputation to have much stronger growth than others in the world even if there is some potential decline. The effect of self-fulfilling prophecy can also be diluted through this good image. You may refer to Asset market in China - perspective in April I.

Errata and appendix: Tsang's Channel

(latest edited at 11:26pm on April 5)

After writing the essay below, I originally feel that there should not have many problems regarding the Tsang's Channel. However, after the dinner, I find certain points needed to be clarified.

Having read some documents in the website and refreshed my statistical knowledge, I realize that I did the wrong things about the band of UU, U, D, and DD (UU: 2 standard deviations from the regression line, U: 1 standard deviation from the regression line, D or DD: below the regression with corresponding number of deviations). They should be re-drawn in the following figure. Sorry about that.

On the other hand, I also discover the discrepancy for the nature of the Tsang's channel in practice. For example, I cut the observation after 2261 away from the complete dataset. In the original figure, observation 2260 is above U. The linear regression line for the Tsang's channel will be different as follow.

Comparing with the original one, you can find that the log-price level is below the line U. Therefore, when one did the Tsang's channel before, the people will not think that at the observation 2260, it is at the high level. Hence, some inconsistent result may appear.

After realizing this, I would like to think that figuring out the duration above some deviations may not be robust. That is, "about 50 days above 1 standard deviation from the regression line (U)" is not robust. Under the new bands, this statement is no longer valid, but the implication that the method is not robust to determine the duration above certain standard deviations from the regression line is still valid. This is what I also want to clarify.

Next, although it lacks certain robustness, the signal in which the log-price level is significantly above the line U is still a warning signal, indicating the price level currently is too overbought. To my understanding, under such a long original dataset, if the regression on the long data series leads to such kind of apparent breakthrough, it has been a very serious moment. Probably, it has matched many sophisticated investors' mind. After the above adjustment, this is still an evidence to support that even if the trend is currently bullish, the tough adjustment is technically near when its momentum continues to pursue the higher level.

By the way, to eradicate the weakness of the Tsang's channel, certain measures can be used.

- By using an even longer time series.
- By repeatedly doing the regression process on the time-series, and recording the UU, U, central line, D, DD at each latest observations to form the reasonable picture.

- By using some modified oscillating tools from moving average indicators.

Regarding the second point, this is my recommendation not to disturb the objective of Tsang's channel, yet to run lots of regression requires some programming cost. Therefore, I would like to delay the works and research this later.

Speculation of the imminent trend - April II

- Possibly face the turnaround

Despite the presence of the good trend, we can still see the already existing phenomena will be a bomb for the current trend.

- General technical analysis

Trivially, talking about the RSI, we can see that if this reaches about 80, the overbought signal will be present so that one has to be conscious on the movement of the price level. If my long-run oscillating indices also reach the threshold, it is particularly dangerous. Currently, the index is not at the risky level, but for the Shanghai A-share stock index, it will be faster to reach the threshold. In terms of the MAs analysis, it is not a good indicator to discover the top, but looking at the difference between the price level and the moving indicators is also valuable.

By using the Tsang's Channel (Spelling mistake may be present), there is also another indication that the Shanghai A-share index has reached the dangerous range as shown in the graph below.

According to the graph above, it is rare to have a log-price series be higher than the U line. Usually it is possible that the log-price series can be over U for more than 50 trading days (assume that 25-day is up and 25-day is down). Now it may be only the start. As entering this range means that the price series is already unstable, it is risky that the turnaround will occur in the following weeks, or within April.

My friends just told me some coincident things on the number 0.618. Based on his discovery, the Shanghai Composite index should have a top at the level of about 3500. I would like to extract the real data to confirm this, or want to ask him again once more.

- Notice the result announcements in Hong Kong and US

It is worth noticing that there will be several result announcements of the H-share stocks in Hong Kong in the coming weeks. They include China Life Insurance and China Construction Bank. After the result announcements, the power to boost the stock indices level would be diminished. Moreover, the financial calendar of US is also noteworthy since the macroeconomic data in February just consist of mixed aspect. The general trend of the economic data may be positively autocorrelated that data in February is a turnaround, such that in March, the performance of macroeconomic data will be deteriorated.

- Other phenomena and conclusion

Besides, the trading data is also controversial. The recent report from Merrill Lynch indicates that lots of Hedge fund have to stop their loss in the short position. Therefore, this boosts the Dow-Jones index to rise. This kind of phenomenon resembles those happening in the Hong Kong stock index in December 2006, where people are afraid of the put position owing to frenzy bullish trend.

Furthermore, the IPO activities are turning to be hot soon, since there will be three renowned stocks listed in the Hong Kong stock exchange soon. This will strongly boost the impetus of the speculation. This kind of frenzy party accompanies both crazy return and crazy plunge. I hope this will happen together in April.

(For the next essay, I will continue to write the essay about the asset market in China.)

* * *

Risk: I find that on April 5, US will announce the non-farm payroll, unemployment rate and much more data in the evening of Hong Kong time. If the ignition of the fall is due to the poor US economic data, there would be the case that the stock index in US will collapse prior to my expected time to collapse.

Speculation of the imminent trend - April I

(This is a topic related to technical analysis, which is not related to the previous series discussing about the asset market in China.)

Previously I mentioned that the stock market will have some similar patterns as if year 1994, 1997, 2000, and 2004, on which there would be plunge in March, April and it would start to be resilient in May. This analysis was finally proved to be correct only in March. However, in the current stage, it seems that certain kind of adjustment has to be made so as to update the previous prediction. It is because the impetus or trend is hard to be resisted, yet I would like to draw some clues to indicate possible situation that the market would turn upside down.

In the first part, I will adopt some technical analysis to indicate the possible strength present in the stock market. In the second part, I will speculate the points and possible scenario so that the sentiment will face the turnaround. I will also state the historical scenario as a reference.

- Strength to support the trend

RSI, a conventional oscillating indicator, shows that both the HSI and HSCE (Hang Seng Chinese Enterprise Index) are approximately 61 and 65 respectively. In terms of the shape, it is represented as an upward trend. At the level between 50 and 70 with upward trend, it is a bullish signal.

As for the 50-day moving average (MA), it shows that both indices have successfully stroke a breakthrough such that the index level of HSI has surpassed the 50-day MA, while HSCE has surpassed the 50-day MA a few days ago. The more bullish signal, which is the 10-day MA surpassing the 50-day MA, will be formed soon. Usually, the 50-day MA is a more insightful indicator than 100-day, 150-day and 250-day MA to indicate the critical trend, while it is not so exhausting when comparing with the MA in shorter windows. Using these indicators, we can see that there will be a secured upward trend.

If one is still not confident enough, one may also look at the rate of return on April 4 (Wednesday). It indicates that many Chinese enterprises have pursued a breakthrough, where they can rise for about 4 to 10% within the trading day. Notice that the turnover is also heavy enough to boost one's confidence of the continuing upward trend.

The risk of this analysis is that there is the Easter holiday present so that the sudden fluctuation of the Chinese stock market will be a shock towards the above prediction.

I also own a self-devised oscillating indicator. The indication shows that both the Shanghai A-share index and Hong Kong's indices do not reach the reasonable peak under the current impetus, provided that no irrelevant shocks are present. However, the reasonable peak is near. I will discuss this in next part, talking about the possible turnaround.

(Continue in the 2nd part of the same title)

Asset market in China - perspective in April III

- Characteristic 4: Shift of sector

Previously in characteristic 2, I mentioned that the monetary policy may produce controversial adjustment for the stock market. Here talking about the fiscal policy and the blueprint of the development, I would say that they are much more controversial for the micro-structure of the stock market concerning the transfer of wealth across different assets in different background. The fiscal policy and the blueprint of development aim at fostering the gradually open economy and granting assistance and allowance towards the industries which are beneficial to the sustainable development in China. From my point of view, these include various aspects discussed below.

In terms of the merger and acquisition, China encourages the companies to carry out merger and acquisition to gain enough knowledge in corporate management and explore the foreign markets. This kind of financial activities are particularly important for the resource industries since this also provides another resource ore for exploration. However, for the real estate and some manufacturing industries, Chinese government will not permit the foreign enterprises to set up the joint organizations with the foreign firms since this may exacerbate the overheated speculative asset markets and suppress the progress of environmental protection.

In terms of the technology and sustainable development, Chinese government has already granted much tax allowance to encourage the self-development in high-tech industries. Apart from this policy, when we analyze the natural market force through the international trade, it has been found that the wage and rent in China have been increased a lot such that many low-tech industries cannot afford to stay in China. Gradually, Chinese high-tech manufacturing industries will be prosperous and competitive as if Korea and Japan produce more high-tech products. Therefore, when one wants to invest in China, they need to follow such kind of trend. As for the sustainable development, obviously, many announcements to close smaller firms have been in progress. The larger firms will be protected since they have economy of scale and afford to spend money on the environmental protection facilities.

Besides this, one can also find that the current account surplus also affects the decision on the taxation, since the heavy load in current account surplus is redundant for the Chinese economy. It may be even detrimental to the world-wide economy. Therefore, those export firms need to sacrifice themselves by having less export tax allowance, or even accepting the export tax.

Chinese government also concerns the fairly equal opportunity to develop in each area. Therefore, the complex income taxation system has been unified to be 25% recently so as to enhance the productivity in the under-developed regions. The simplified taxation system for the entrepreneurs is also a means to provide a transparent system with a view to fostering better standard in fiscal policy.

Finally, there are also some unperceivable noises of the crack-down and the supports which are specific for some industries. This requires close attention on the Chinese politics.

(Continue)

Asset market in China - perspective in April II

- Characteristic 2: Adjustment through alternative policies, with continuation of growth

After considering the long-term economic growth, one of the possible causes of the adjustment is mostly attributed to the policies including monetary policy, fiscal policy and development blueprint in China.

For the monetary policy, China is actively involved in the role to stabilize three economic variables, price level, fixed asset investment, and current account surplus against US. Originally, the interest rate policy can lead to conspicuous shocks towards the financial market in China so that it is useful as a stabilizer. However, as Renminbi became more flexible since July last year, the interest rate policy became weaker in controlling the overheating in economy. People are willing to invest in Renminbi's asset which further boosts the asset price bubble. Therefore, the recent announcement by Wu Xiaoling, the vice-chairman of PBC, proposed active and prudent monetary policy by using the reserve ratio for lending authority and open market operation.

From my point of view, it should be a new means to curb the overheating economy, which is challenging but implying that Chinese monetary policy would be more sophisticated to smooth the business cycle. Moreover, until recently, the open market operation is not the main tool in monetary policy. The larger the scale of open market operation is, the chance to develop the bond market is also larger. All these messages seem to be good for economy of China.

Regarding the fiscal policy and the blueprint of development, its concern seems to focus on the re-distribution of wealth to assist certain sectors. I delay the discussion about these until it comes to the characteristic about the shift of the sectors.

- Characteristic 3: General recession pattern and its time-lag (inspired by Mr Cho's article)

This is adopted by a short message from Mr. Cho's article written on Mar 28, 2007. It mentioned that an analyst believed cycle of the Chinese stock market would have time lag when it is compared with most of the stock markets in developed countries. I would like to elaborate more about this.

Now that the US asset price decline is salient to the investors, the stock market in US will decline at the same time as an example of efficient financial market. This also signals the other mature financial market around the world, which are also susceptible to the risk of recession in US. In UK, its housing market bubble may be even triggered by the recession in US.

However, in China, its financial market is relatively close that the people may regard the outside detrimental factors to be irrelevant. Moreover, Chinese investors are so optimistic about the Chinese economy. Recently many Chinese investors are thought to be the example of herds without investment knowledge at all. All of these phenomena enable me to see that the decision mechanism for the Chinese investors should also possess the time lag.

Probably, more adverse information is needed to overthrow the bullish regime in China. This kind of adverse information involves conspicuous reduction in export due to possible recession in US. The recent news regarding the countervailing duties is not striking enough to show the potential crises on the Chinese export sector towards the Chinese investors. After consecutive bad news imposing on the firms, the Chinese investors start to realize their situation affected by the foreign economy and finally leads to the bearish regime.

(Continue)

Stocks recommended by HKET in 2nd quarter

Name (Code) Buy Sell Stop-loss Incl.
三林 (3938) 2.75 4 2.4 No
雅居樂 (3383) 7.5 8.8 6.8 No
湖南有色 (2626) 5 6 4.3 No
中通 (552) 5.2 6.5 4.4 No
香港中旅 (308) 3.5 4.5 3 No
亞洲金融 (662) 3.8 4.5/5 3.1 No
建行 (939) 4.45 5 4 Yes
中國建築 (3311) 5.5 7 5 No
中交建 (1800) 9.3 10.0/11.0 8.4 No
天津港 (3382) 3.15 3.6/4.0 2.7 No

This portfolio is constructed by HKET in 2nd quarter. When the market lacks direction, this portfolio became the choice for the lazy investors or anxious investors.

One could also find that this portfolio conveys some information about the price level of the market. Most of these stocks have much lower purchasing price level than the current price. As we saw today, only China Construction Bank (939), China Communications Serives (552) and Asia Financial Holding (662) have reached the target price. Moreover, only China Construction Bank could be exactly collected in my system. Therefore, I guess that this time HKET wanted to be cautious to prevent the scenario in the 1st quarter.

For Asia Financial Holding, I suspect if this kind of price-setting would be too aggressive, since technically speaking, its momentum seems to be reduced although indeed it has been ignored for such a long period.

Disclaimer: I do not bear any responsibility and liability for my comment and these recommendation if you lose by adopting my opinion.

Asset market in China - perspective in April I

After the previous analysis and quotation of the facts, I would like to have some analysis on the future trends of Chinese stock market. It is noteworthy that speculation on the clear trends is usually similar to the pseudo-science. If I make the analysis in the strictest logic, distinct conclusion would probably not arrive. Here I would like to share my thoughts, so that different scenario, including contradictory pairs, will come out. As for the probability, it is still implicit. Therefore, overall the prediction would have wide range of possibility. For the speculation of trend, which is of the interest of main group of investors, I would like to draw this after this analysis.

I will state my scenario from long-run aspect to short-run aspect, and from macro-aspect to micro-aspect.

- Characteristic 1: Strong economic growth relative to other nations in the long-run

From my point of view, it should be the ground that Chinese economy basically should have sustainable growth rate above 7-8% in the near future. The reason is owing to the expectation of improved infrastructure in the future, newly developed law for the property right, investment in education, continuation of international trade in the skilled sector, and the sophisticated stabilization policy adjustment in the future. One may regard this as the ordinary growth resembles those happened in Asian tiger.

However, as a country with complex background, there is still challenge on the continuation of growth in the long-term. On the one hand, the one-child policy has led to the polarization of hierarchy in which the older generation may have spoiled the young since the young becomes precious in their mindset. Moreover, the young may not afford to pay the pension for the old since the number of the elderly will increase.

On the other hand, the problem of income inequality also entangles Chinese economic growth. Due to evolution from low-skilled to high-skilled industries, the flow of income becomes conspicuous which may make those people suffer discontent. Another critical problem is the corrupted government official still having power to some extent. Government should have noticed this so that the crack-down on these acute issues are still in progress. When one tries to invest in China, they should also notice the shortcomings and potential risk in the Chinese political, business or geographical culture.

If the growth could resemble the economy like Hong Kong, Korea and Singapore, together with the time of which the elderly would cluster in the future, I would speculate that the growth would be sustainable until year 2018 to 2022, i.e. there would be approximately ten years for the growth, given that no disastrous events occur.

(Continue)