It has not been a good year for the Shanghai stock market. Since its closing peak at 6092 in October 2007, the closing high in the past year or so on Shanghai's SSE composite was 3471, on August 4 last year. Since then the market has been pretty bleak. The SSE Composite finished 2009 by dropping nearly 6% from that high, to close at 3277.
This year things got only worse. By May 20 the market had dropped a further 22% to close at 2556, and then bounced around for the past ten days closing yesterday at 2568. In my May 12 blog entry, I finished the piece by saying:
"Last Friday the SSE Composite closed at 2688. I bet it is much higher by the end of the summer."
Obviously my timing was off. Within a week of my prediction the market had managed to lose another 132 points. I still believe that the market will be higher by the end of this summer, and that within weeks we will see moves by the regulators to prop it up. With all the liquidity sloshing around, all we need is a reasonable period off stability before the market comes roaring back, I suspect.
So am I predicting a strong economy? Not really. It is tempting to read falling stock prices as an indication that Chinese investors believe that the economy is poised to slow dramatically, and if the market surges, that Chinese growth is back, but we should be very cautious about how we interpret the meaning of the gyrations in Chinese stocks.
We're used to thinking about stock markets as expected-cash-flow discounting machines, and we assume that stock price levels generally represent the market's best estimate of future growth prospects, but this is not always the case, and it is certainly not the case in China. I am often asked to comment on big price moves on the Chinese stock markets and what they mean about growth expectations, but I usually try to caution people from reading too much meaning into the market.
Three investment strategies
To see why, it is probably useful to understand how investors make trading decisions. This blog entry is going to be a pretty abstract piece on how I think about the underlying dynamics of a well-functioning capital market, and how these apply to China. I have spent…
