The Future of China's Stock Market Remains Bright

Author: [Mu Zi]
Source: [Fund Analysis]
Article type: Regular article
Published: 2007-10-26 18:59:06
Column: Expert Perspectives

The broad market topped out and pulled back at the 6100 level as anticipated in the "Late 2007 Market Analysis" article written by this column in September. That article included the following analysis: "Since last year's market gain was 130.43%, with a close at 2675.47 points, by corresponding proportion, 6165 becomes a benchmark point for this year. Furthermore, the Shenzhen Component Index in its 1996 rally — much like this round of the Shanghai index — also slightly broke below 1000 before launching, and the former ultimately topped at 6100. Therefore, the 6100 area is a position deserving special attention for the latter."

And a concluding paragraph: "Conversely, if the rampaging of capital exceeds reasonable bounds, the market will evolve into a frenetic trajectory — forcibly breaking through the aforementioned 6100 zone within this year. In that case, a correction exceeding the 5/30 level becomes difficult to avoid."

Now, the market has experienced a sharp pullback after 6100. At the time of writing, the market on Thursday was undergoing a round of heavy selling, setting a new correction low, with individual stocks plunging across the board. Only about 100 stocks in both markets were in the green, while over 400 hit the daily limit down. What exactly is the future of China's stock market? Is 6100, like 1997, the beginning of a major correction leading into a long, drawn-out bear market? This is a question that must be taken seriously.

Clearly, the current 6100 level is utterly incomparable to the 6100 of the 1997 Shenzhen Component Index. To understand this, one need only observe the different economic backdrops. China's economy and its stock market future remain bright. The fundamentals of China's economy have not undergone any substantive change, and all factors supporting a long-term bull market remain in place.

The long-term blueprint for China's stock market was clearly drawn in this column's very first article, "The Divine Continent Has Its Midday Sun — Ten Thousand Nations in Court Robes Dance at the Nine Shao Ceremony." At that time, the market was still buffeted by wind and rain below 3000. That article explicitly stated: "It is laughable to talk about stock market bubbles before total market capitalization exceeds GDP. Before China's stock market capitalization exceeds its GDP, the first phase of the rally will not end."

Subsequently, all of this was realized. Moreover, to this day, this first phase of the rally has still not ended. After this medium-term correction concludes, this first phase will continue to unfold and continue to make new highs — this is beyond doubt.

However, what is needed now is a medium-term correction. For the future of China's stock market, this medium-term correction is necessary. Using a reasonable correction to accumulate new energy, making the market's medium-to-long-term trajectory more robust and the foundation of a 20-year-plus bull market more solid — this is both necessary and inevitable.

Imagine if China's mainland stock market were to go through a Japanese or Taiwanese-style drunken stupor followed by a fifteen- or twenty-year bear market — who would ultimately be harmed?

Particularly for China today, the economic transformation is not yet complete, and the new economic structure and operating model have not been fully built. Once the capital market is destroyed, the core driving force needed for economic transformation would be utterly lost, ultimately harming the real economy — and the health of the economy directly affects everyone's livelihood. The significance of long-term, stable economic development for Chinese society today cannot be overstated.

China's economy and China's stock market need a steady bull, not a raging bull.

China's stock market bull remains intact. The future of China's stock market remains the most opportunity-rich, highest-potential market in the world, with the grandest prospects, destined to become the world's largest market. The storms that must be faced will only make it healthier. Without such a grand vision, one is destined to never succeed in this market.

China's stock market is full of opportunities, with an unlimited future. But how to make these opportunities and this future your own — that is the most important question for everyone. This market doesn't fear making mistakes; it only fears refusing to correct them. Take a good look back at your own trading, and you'll probably find better answers to the question above.

For the market ahead, China-prefix heavyweight stocks and second-/third-tier theme stocks will continue to be the market's two centers of gravity. Currently, theme stocks have already pulled back substantially, laying the groundwork for future moves. As for China-prefix heavyweights, around the time of PetroChina's return to A-shares, there will still be performance opportunities. But afterward, they must face an awkward question: when many China-prefix stocks have become the world's number-one by market capitalization in their respective industries while their earnings lag far behind international peers, how can holders maintain confidence — besides continuing to paint rosy pictures, is there anything fresher to say? Asset injection and whole-company listing provide thematic support, but from a medium-to-long-term perspective, this is far from sufficient.

The ultimate magnitude of this medium-term correction will depend on the catch-up selling pressure of China-prefix heavyweights. There is a variable here: the timing of index futures launch. If that comes very quickly, then before the catch-up decline, there may actually be an even more frenzied rally, creating an even larger bubble. Should this occur, the ultimate magnitude and duration of the correction will increase greatly — this is one of the reasons this column has consistently opposed the current launch of index futures.

(Special Senior Advisor to this publication, Mu Zi)