Tags: China | Bubble | Stock Market | Economy

China Meets the Definition of a 'Bubble'

By    |   Wednesday, 17 June 2015 01:24 PM

Bubbles are frequently spotted in financial markets but in reality they rarely occur.

There are three requirements for a market bubble — a price rise that is unsustainable; price levels that are unsupported by the fundamentals; and the introduction of new ways to let speculators participate in the market.

Stocks in Shanghai meet all three requirements and are officially in a bubble.

After gaining nearly 60 percent since the beginning of the year, the pace of gains in the Shanghai Stock Exchange is now unsustainable.

Despite the rapid gains, China’s economy is slowing and bad loans are threatening the banking system. Economic fundamentals are weakening with stocks at historic highs.

Valuation is also at an extreme. The price-to-earnings ratio, one measure of valuation, is near 70, almost four times higher than average.

Regulators have done their part to fuel the bubble by expanding access to China’s stock market so that it is easier for foreigners to buy.

Everything is in place for a bubble and a crash is the inevitable end to the bubble. Maybe this time will be different, as speculators are fond of believing, but in the past five hundred years bubbles have always ended in a crash.

Bubbles also have a history of spreading. This time will not be different. Losses in China can force leveraged investors to liquidate trades in other markets and selling will drive prices lower in those markets.

While we know what will happen, we do not know when it will happen. This means now is the time to build cash in anticipation of the buying opportunity that lies ahead.

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Bubbles are frequently spotted in financial markets but in reality they rarely occur.
China, Bubble, Stock Market, Economy
Wednesday, 17 June 2015 01:24 PM
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