A Warning Sign For Chinese Stocks?

Anyone who follows international markets has noticed the tear that China’s stock exchange, the Shanghai Composite (SHCOMP), has been on for the past year. With returns of over 90 percent in the past year, many investors are kicking themselves for not getting into China sooner. The real question is: Is there still room for the Shanghai to run?

China’s latest GDP growth number was 7 percent as expected, still relatively one of the highest growth rates in the world and much more impressive than the 2.2 percent GDP growth rate many American investors are accustomed to with the United States. With a consistently low unemployment rate hovering around 4 percent and reduced reserved requirements instituted by the People’s Bank of China, many people see China as an attractive investment opportunity with a lot of positive indicators. China has also greatly benefited from the decline in oil prices given they’re the largest oil importers in the world.

But despite performance of the SHCOMP and of the aforementioned indicators, GDP growth numbers have been on a downward trend from 7.9 percent in Q1 of 2013. The unemployment numbers are considered by most to be useless given they only take into account urban workers who are receiving unemployment benefits and fail to account for the 600+ million rural Chinese citizens as well as 200+ million migrant workers.

A Warning Sign?

These unaccounted for citizens makeup over 60 percent of the Chinese population.

The oil market looks to have hit a bottom lately and though it still has room to move down further, prices seem to have steadied for now. A spike in oil would be incredibly painful to the oil-dependent Chinese economy.

To the external onlooker, Shanghai is simply a pot getting ready to boil over. The massive influx of Chinese investors is driving the Shanghai to illogical levels. According to Bloomberg China economist Tom Orlik, 5.8 percent of China’s new investors are illiterate and 60 percent have less than an 8th grade education.

As the graph shows below, the last time new account openings reached these levels they were followed by around a 70 percent correction in the Shanghai just a few months later.

Ghost Towns

The problem of Chinese ghost towns seems to only be getting worse. Even though the urban population rate has grown from 49 percent to 53 percent from 2010 to 2013, the number of unsold residential properties has been steadily taking off since 2011.

With this flood of unsold properties in the market, it’s not surprising to see the steady decline in Chinese housing prices into negative YoY change from mid-2014 to now.

China seems like a great place to be if it were January 2014. Since then, thousands of uneducated investors have been entering the market and artificially driving up prices. Drags in the real estate market and less than impressive numbers with falling exports, prices, and manufacturing data signal a likely turning point in China’s slowing economy as it attempts to transition from a growth stage into a matured nation.

The country is no longer the emerging market that investors see an excess of growth potential in and shouldn’t be treated as such. With the reserve requirement reductions we’re likely to see from the Central Bank, it’s possible that reckless lending could become a feature of the Chinese economy in the latter half of 2015 and 2016.

Excessive lending, a lagging real estate market, and uninformed investors have all been traits of United States’ contractions in the past.

Despite this, the Shanghai index still has room to run. There will continue to be an inflow of investors to the market and many people still believe in China’s growth.