Investment bubbles always look so obvious in hindsight. But when you’re in the middle of one, it’s hard to fight the crowd, even if that little voice in your head tells you to run for the hills.
Why? Bubbles produce compelling narratives that give people reasons to believe. The Internet is changing everything. Housing prices never go down. Tulips are the most precious commodity on God’s green Earth, etc.
Now the same thing is happening again in China, a market that has had one huge bubble burst only recently. The Shanghai Composite index briefly topped 6,000 in October 2007 only to plummet to just above 1,700, a sickening 70% plunge in only 12 months.
They’re counting on China’s central bank to keep cutting rates. It already has reduced them three times in the past six months. Sound familiar?
Also, the Chinese government has eased trading restrictions on foreign investors. On Tuesday, index provider MSCI said it “expects to include China A shares in its global benchmarks” once it works out some issues with Chinese regulators. A flood of institutional money would presumably follow.
Indeed, mutual fund company Vanguard said last week it would gradually increase the number of mainland China-traded A shares in its Emerging Markets Stock Index Fund VEIEX, +1.11% and ETF VWO, +1.46%
This macro “story” has powered Shanghai 150% higher in the past 12 months. Shenzhen and other mainland markets with riskier, more speculative stocks have nearly tripled.
With the animal spirits unleashed, average Chinese investors are piling in. In a reverse of what happened in the U.S. in the 2000s, Chinese investors fleeing a busted housing market have thrown their money into stocks. Talk about going from the wok to the fire!
Consider these worrisome signs:
• China’s GDP growth slowed to 7% in the first quarter, the slowest since the Great Recession, and that figure may be overstated by 1 to 2 percentage points, according to Capital Economics.
• Analysts project earnings growth of companies listed on Shanghai and Shenzhen will be 7% in 2015, the lowest in three years, Reuters reported. The biggest culprits: banks grappling with a surfeit of bad loans
