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Market commentary June 2007

By June 4, 2007No Comments

SUMMARY.  There are more twitchy media reports about the Chinese stockmarket, which seem difficult to justify. Even heady Chinese valuations do not look so high when historical precedents are considered. Global markets are coping well with a number of potentially serious problems, so keep enjoying the party.

Another month another welter of panicky media reports on the Chinese stockmarket.  With the capitalisation of Chinese stocks being only 7% of the global total, it is difficult to rationalise this twitchiness.  As we mentioned previously, investors (particularly those that are geared) are very well aware that they have good profits on paper, and are edging ever closer to the exit.  Yet the institutions in this crowd don’t want to be seen to sell ahead of their peers – the risk of ridicule and redundancy is a powerful motivator.

This twitchiness might also arise from a sense that where go Chinese stocks goes the Chinese economy, a key underpin for robust global growth in recent years.  Yet Chinese investors still have 95% of their financial assets in cash, so severe stockmarket falls should not have a significant or long lasting impact on the wider Chinese economy.

Nor is there the overwhelming complacency on stockmarket risk that tends to mark the most worrying periods.  Many major markets are fair value in price earnings ratio terms, as profits have risen faster than markets.  And even Chinese stocks are not necessarily massively overvalued.

For example, while domestic Chinese stockmarkets are on price earnings ratios (PE) of 35, which would be considerd very high in developed economies, does not necessarily indicate that China is near a significant peak.  A good analogy is Taiwan in the late 1980’s, where the market traded up to a PE of 100 before turning down.

It is also encouraging that financial markets have been able to withstand a number of potentially serious problems without widespread casualties.  For example, one European bank has closed a hedge fund as a result of US sub-prime mortgage problems, but this is a very isolated incident.  While financial innovation is frequently lauded as the reason why the system is more resilient to shocks, abundant liquidity is surely the much more significant, and certainly impermanent, factor.  The same event could have a much more serious impact in times of less abundant liquidity.  What might trigger the latter is open to debate, (sharply higher interest rates?), but until it happens, enjoy the party.

Dennehy Wealth