HKHSI and NASDAQ Downturn (5/5/2000)

Major Correction in the Horizon (4/15/2000)

Prof. Kai Keung Mark is a retired professor, Dept. of Biology, The Chinese University of Hong Kong and Dept. Head and Principal Lecturer, Dept. of Science, Hong Kong Institute of Education. He has three biotechnology patents. He uses his understanding of high technology to forecast market movements . He has published 13 articles in Financial Trend, and leading Hong Kong stock analysis journal plus many other Mark's letters since 1987. His prediction reliability rate reached 80%. He accurately predicted the October crash (10/18/87), the bottom level of 1990(3/5/90), the peak level of 1994 (5/11/92), the peak level of 1997 (2/12/96), the peak level of 2,000 (8/22/99), the peak in March 2000 (2/20/2000), the bottom in September, 2001, the US bottom in 2003 (5/28/2003), the HK bottom in 2003 (6/13/2003), the US peak in 2007 (11/14/2007), and the HK peak in 2007 (1/9/2008).

Bear and bull elements - China Markets

The author recognized the formation of the Chinese stock market bubble before any one start to worry about it ( Jan. 4,2007), but this stock price bubble keep on expanding with time, and thus make the author very nervous about its potential danger (Nov.14, 2007; Jan. 9, 2008).

From historical records, most bubble end up bursting with a bang. however, it is very difficult to pin point the exact time of bursting.

Before making a remark on the Chinese market, the author wants to out line the bear elements first, then the bull elements.

The first bear element is that Chinese markets are major capital markets or at least an important emerging market. For example, Shanghai A index has risen 5.8 folds since mid 2005,(see fig.1) thus the rise is too fast and too extensive. Therefore, it is clearly in a bubble, and might burst with serious fall outs.

The second bear element is that Chinese now face serious inflation with CPI reaching 8.7% for Feb. 2008, thus have to use drastic measures to cool off the economy. The central government is firmly commited to this policy. A lot of cool off measures have been carried out during 2007, so the pressure has been building up, but not yet enough to turn the tide, As the cool off pressure continue to build up, at some point, the tide may suddenly turn, and the stock market bubble might burst like the collaps of large structures due to metal fatique.

Thirdly, despite Chinese government's effort to cool off the economy with 10 increases of bank deposite reserve in 2007, and two times in 2008, reaching the world's highest rate of 15.5%. The Chinese Government also raise interest rate 6 times reaching 4.14%, yet money supply is still increasing out of control, with M2 increased 16.72% for Dec. 2007, and 18.94% for Jan. 2008. So this is a dangerous situation.

The fourth bear element is that the market contains too high a proportion of unseasoned investors. Fuel by the strong bull in the international markets during 2005-2007, Chinese stock markets suddenly turn and shoot up like a rocket. Such catch up is coupled with very good performance among the Chinese corporations during this period. Such fast and consistant rise of the Chinese markets ( Shanghai A index and Shenzhen A index ) have attracted very large population in China to participate in the stock market trading, hoping to make a fortune. most of them are new investors with no experience. They chase after limited supply of stocks available forcing price to reach unreasonable level with average P/E of 50. Most of them also exibit a strong herd behavior which is very common in emerging markets. Because the high proportion of unseasoned investor in the market coupled with the market at very high level, the situation can be dangerous.

The fifth bear element is the drasstic changes in international economic outlook by early 2008, from strong bull to serious bear. The economic slow down worldwide is a certain thing for 2008. Because China's economy is still significantly based on export activity, so economic slow down clearly will affect the performance of most Chinese companies. When most Chinese corporations perform worse in 2008 than 2007, which is also quite certain, Chinese investors may suddenly realized that Chinese stocks are extremely overpriced, and the growth outlook as imposed by their P/E ratio are not real. Such impression or outlook may suddenly trigger a flood of selling orders that induce a stampede.

The sixth bear element is the termination of the blocker period of the major share holders for most of the major Chinese corporations. Most IPO has blocker period, usually are 6 months after IPO, but some are as long as 1-2 years. Since majority of stocks are recent issues, their blocker period should end recently or in the near future. This implies that there are large selling volume when any bad news or market fall appears. On top of this, there are large scale and widespread secondary offerings among the major blue chips stocks in China. Both are important factors that push the Chinese stocks to go down further, and limit the extend of rise.

The seventh bear element is that herd behavior is now the dominent driving force in market movement. The inexperienced or unseasoned investors constitute a large proportion of investors. Their herding behavior are important source of instability to the Chinese stock markets. These inexperienced investors follow the herd to chase after stocks to unreasonable high level, which create a strong force to swing downward. During the down swing, both the herd behavior as well as their fear create excessive selling pressure, and also push price to excessive low level or even worst, trigger a stampede that lead to the bursting of the bubble.

The eighth bear element come from technical chart patterns. Shanghai A index from the lowest of 1100 point on June, 2005, and shoot up like a rocket (see fig. 1), rising with three major waves and reached 6,400 points on October, 2007. On the last wave of rise from July to October, 2007, the rise also form three smaller up waves whithin a narrow up channel ( see fig. 2 ). From the Elliott wave patterns, the bull rise usually turns on the third wave. Now the rise did turn, breaking both the narrow up channel from the three smaller waves, and now also the third major wave. The first wave of fall started with kiss good bye (KG ) after penetrating the channel down side. Then proceed in three waves with three fan lines from 6400 to 5,000,a drop of 1,400 points. the recovery phase produce an up wedge from 5,000 to 5,750 points. The second down swing started with breaking this up wedge down side, and drop below 4,500 points, another 1,250 points drop. The extend of drop far exceed the expectation of a normal bull correction. Therefore the chart pattern indicated that the bull run has ended, entering the bear phase which is consistant with the international trend.

After outlining eight bear elements, it is fair to provide the bull elements.

The most important bull element for the Chinese market is that now China's economy is in its final bull phase, with very good profit earning for most of its major corporations, and the business boom is clearly recognized. Because of such attrative outlook, large population flock to the stock markets, even those inexperienced laymen, thus P/E is very high, stock index and volume make historical records, and the real estate market also boom excessively. The boom induce inflation, and central government tries to cool off the economy by increasing the bank deposite reserve as well as raising interest rate. These are standard stages of business cycle. However, stock index are leading indicators that usually is 3-9 months ahead of the economy.

The second bull element is the Beijing Olimpic games this coming August. A lot of Chinese believe that the central government will not use drastic means to cool off the economy , hoping that the boom might last longer till the Olimpic game is over. It is true that the Chinese markets have been significantly influenced by administrative means. However, how experienced are the financial adminidtrators who hope to deflate the bubble to avoid a bang is still hard to say.

Given the pros and cons of the Chinese market, the author's assessment is that the Chinese market is highly likely to drift further downward in 2008, or even worst is that the Chinese stock market bubble might burst driving the stock indexes to extreamly low level, and take loonger time to recover.

As indicated above, the upside potential is low, while the down side potential is quite high for 2008, so the author's recommendation is " SELL ".