And We All Fall Down !!!

The Event:
The Chinese composite index – Shanghai Composite Index – fell more than 7.5% during the day and closing down 5%.
The Reason:
The Chinese government unexpectedly cut fuel prices which led to sell off in large cap counters. Steel and Real estate stocks also crashed on overvaluation concerns.
The Effect:
The Shanghai crash led spread to cause a rapid fall in other Asian markets too, which (in any case) were overbought and overvalued.



What now?
Will this start a further sell off in the Asian markets and hence the world markets? The coming days will answer this but let us dig deeper in to the reason for this fall.

The Chinese stock markets have been the best performing markets in the last six months. The huge rally was a result of huge government stimulus, increased bank lending and signs of economic recovery. While signs of economic revival may be one reason, the major reason for the rise seems to be the excessive liquidity in the system on account of the huge stimulus package. Thus one may also argue that the current rally was not fundamental-driven to some extent and it was the excess money flow which caused the rise – a phenomenon which has previously led to creating of ‘market bubbles’!

And unfortunately, this phenomenon is not restricted to the Chinese markets- but it is true for almost all the markets the world over, including India. There have been many concerns that the stimulus money has been finding its way in to the financial markets, rather than going in productive use to revive economy.

It seems that the world is tracking the stock markets to get signals of whether economic revival has taken place or not! While, in reality, shouldn’t it be the other way round??

The Chinese crash today may well be a warning signal for other markets as to what may happen if the ‘excess liquidity’ is withdrawn from the financial markets or if investors suddenly (?) realize that what they are buying is, in any case highly overvalued! Overvaluation has been a concern especially in the Asian markets, including India. While the Chinese markets traded currently at a P/E multiple of 35 times, the Indian markets too are at 21 times P/E multiple – near the upper range.

Investors should not ignore this and not take it as a ‘one-off event’ and must become more cautious in stock picking. “A lost opportunity may many a times be better than an actual loss”.

CA Rajiv D Khatlawala
Head of Research and Training
JHAVERI Securities Ltd.