China's Stock Market and Property Bubbles

I was visiting Shenzhen last week and during my visit I was speaking with alumni who work in the investment industry. The main topic of conversation was the huge increases in stock and property prices in China. The Shenzhen Index has doubled since January. The Shanghai Composite has increased 140% in a year. Jincheng Umbrella Holdings floated on the Hong Kong market in February and its shares are up 1700%!  Click here for a New Yorker piece on the Chinese stock market and here for a tongue-in-cheek piece by Tyler Cowen over at Marginal Revolution.

After speaking with alumni and after making comparisons with historical bubbles, it looks like China may be experiencing a simultaneous bubble in its stock and property markets. Here are five reasons why I think that China may be experiencing a bubble. 

1. Chinese stocks cannot be short sold and property by its nature cannot be short sold. Constraints on short selling have been common features of historical bubbles.

2. The People's Bank of China has been engaging in monetary stimulus and easing credit conditions. This makes it very easy for individuals to borrow to buy apartments and stocks. The rise of the shadow banking industry in China has also contributed to the the easing of credit conditions. Loose monetary and easy credit conditions have been associated with many historical bubbles.

3. The best performing stocks on the Shenzhen market are high-technology and e-commerce stocks. According to my sources, many of these companies have poor fundamentals and prospects. Notably, many historical bubbles have been associated with new technology. Indeed, the description of what is happening on the Shenzhen market reminded me of the dotcom bubble which burst in 2000.

4. There has been a notable increase in the stock-market participation rate, with many retail investors entering the stock market and many of them buying stocks on margin. This is reminiscent of the 1929 Wall St crash. Retail investors have also been borrowing heavily to invest in property, which is exactly what was happening in the West prior to the global financial crisis.

5. Taxi drivers in Shenzhen are giving investment advice on stocks and property. As Charles Kindleberger noted, one of the key warning signs that a  bubble is about to burst is when shoe-shine boys, bootblacks and waiters start giving stock tips.  

Source: New Yorker