Understatement of the Month Award

The understatement of the month award goes to Garry Evans at HSBC for his comment on the Shanghai Composite Index "I think the market had gotten a little too expensive".

China's leading stock index tumbled nearly 9% Tuesday, marking its biggest plunge in a decade, on concerns of more economic tightening measures as China's parliament prepares for its annual session next week.

The Shanghai Composite Index, which tracks shares listed on the larger of China's two stock exchanges, tumbled 8.8% to 2,771.79. The declines rank as its biggest single-day drop since the benchmark plunged 9.4% on Feb. 18, 1997, which reportedly came after the death of reformist Communist Party elder Deng Xiaoping.
The Shenzhen Composite, a gauge of shares on China's smaller exchange, shed 8.5% to 709.81.

Analysts said the declines, which came a day after the Shanghai Composite ended at an all-time high, were sparked by concerns the government may implement new measures to cool speculative behavior.

Market watchers said investors in China were spooked by rumors the government may impose a 20% capital gains tax, while comments by People's Bank of China Governor Zhou Xiaochuan, published in a Chinese-language publication Tuesday, also stirred unease about the prospect for further rate hikes.

"If inflationary pressure increases the central bank should consider monetary policy action, including interest rate policy," the Xinhua Finance news service reported Zhou as saying in the interview, which was published in the Hong Kong Commercial Daily.

Investors were also wary that additional macro-tightening policies could be in the works after the annual session of the China's National People's Congress, which gets underway March 5. China's central bank lifted the reserve requirement on domestic banks by 50 basis points from Sunday.

"I think the market had gotten a little too expensive and had reached about 26 times forward price earnings, at the top of what we see as a fair value range," Evans said. Prior to Tuesday's decline the Shanghai Composite had risen 14% year to date, following on from a 130% gain in 2006.

Chart Defining "A Little Too Expensive"



How did this happen?

Inquiring minds might be wondering just how the market got "A Little Too Expensive". That's a good question. For the answer we turn to Eager Chinese grab bull market by the horns.

February 16, 2007

SHANGHAI — After emptying his savings account, Lu Gang borrowed funds from his mother, relatives and friends. Now he's planning to mortgage his home.

Where's all the money going? Into China's booming stock market.

"Both of my parents think it's crazy, but I think it is OK," said the 26-year-old investment company manager, who's already sunk about $15,000 into stocks since getting in on the action last summer. "If there is opportunity, you have to grasp it."

Millions of Chinese have entered the trading frenzy in the last year amid the strongest bull market in the nation's young capitalist history. The Shanghai composite stock index has doubled since August after four years of dismal performance. On Thursday, the Shanghai index set a fresh record, gaining 3% to finish at a whisker below 3,000.

Many individual investors have reaped handsome profits, but a growing number of them are tapping their credit cards and using their homes as collateral for cash to buy more stock, say bankers and analysts. That has stoked government concerns about excessive speculation.

China prohibits banks from giving consumers home-equity loans to play the stock market. So many people are hocking their homes with pawn shop dealers, who typically front borrowers as much as 60% of the value of their homes — but charge an annual interest rate of 36%.

China's Pawn Assn. recently warned its members about the risks of making such loans, saying that although it is quick and easy to advance cash to clients, collecting on loans in default is another matter. "It's quite complicated and troublesome to transfer ownership," said Wu Xianda, director of the association, which has about 100 members.

At Jinbao Pawn Shop in Beijing, manager Hu Bo usually sees a surge in business this time of year. Before the lunar New Year, which falls on Sunday, bosses seek extra cash to settle debts and pay bonuses to employees. But Hu estimates that the stock mania has helped push up Jinbao's mortgage loans by at least 30% this year.

He recalled one client in particular, a man in his 40s who mortgaged his 800-square-foot apartment in Beijing for $40,000. "I told him that he might suffer losses, but he insisted anyway. He was very confident. He said, 'I have targeted one good stock and I just need the money for one month.' "

"I just need the money for a month". Oops. It seems the market gave you less than two weeks. The unanswered questions of the month are as follows: "How many homes is Jinbao's Pawn Shop going to own at the end of the month, and what will manager Hu Bo do with them?"

Durable Goods

Meanwhile back in the states Core capital-equipment orders post biggest drop since January 2004.

New orders for U.S.-made durable goods plunged 7.8% in January as nearly every category of manufactured goods declined, the Commerce Department reported Tuesday. Transportation orders fell 18% in January after rising 3.1% in December. Aircraft orders fell 60.3% in January. But the weakness in January's durable-goods orders extended well beyond the aircraft sector. Orders excluding transportation fell 3.1% in January. This is the third drop in the past four months and the sharpest decline since July 2005.

Orders for core capital equipment, the kind of goods producers invest in to build their productive capacity, fell 6.0% in January, the biggest drop since January 2004. Core capital equipment orders (which exclude aircraft and non-defense goods) are the best monthly indicator of capital expenditures.
Economists said the drop raised questions about how strong business spending will be this year.

"With capital spending having been down in the fourth quarter, this trend is not something that makes one comfortable about the strength of the economy," said Joel Naroff, president of Naroff Economic Advisors. Ian Shepherdson, chief U.S. economist at High Frequency Economics, went so far as to say the factory rector was in a "recession."

The Yen

The weak capital goods report and the implosion in Asia seems to have gotten the carry trade players a bit nervous. Here is a chart of the Yen.


The Euro



The combination of the Euro, Yen, and Pound all being up means the US$ is sinking. But guess what? Treasuries are continuing their rally and the yield curve is further inverting.



Thanks to Bloomberg for the above chart. Click to refresh.

Yesterday, in Does anything mean what it used to? I noted that Bernanke thinks that the data suggests a "somewhat firmer economy" and Greenspan thinks housing has bottomed, and neither thinks the inverted yield curve means what it used to. Meanwhile fresh off the presses today The Boston Globe is reporting Massachusetts foreclosure filings smash record.

January had the highest number of monthly Massachusetts foreclosure filings in at least two decades as local consumers struggled to hang onto their homes, according to a new report.

Last month, 2,207 foreclosure filings - or 110 every business day - were submitted in Massachusetts, more than double the number of a year ago; filings in January 2007 were up 105 percent from 1,076 filings in January 2006, according to ForeclosuresMass.com, a Framingham firm that provides online Massachusetts foreclosure data to investors, real estate agents, and lenders.

"The flood of foreclosures in Massachusetts is not only continuing; it has reached a new high," company president Jeremy Shapiro said in a statement. "The fact we are starting the year with the highest number of foreclosures we've ever recorded for a single month is more than significant - it's ominous."

Message to Ben Bernanke: It's high time for you and Greenspan to leave Wonderland and face the real economy.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/