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Cablegate: Shanghai Stock Market: Up, Up, and a Bump: Where to Next?

VZCZCXRO9767
RR RUEHCN RUEHVC
DE RUEHGH #0028/01 0240918
ZNR UUUUU ZZH
R 240918Z JAN 08
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6620
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7151

UNCLAS SECTION 01 OF 03 SHANGHAI 000028

SIPDIS

SENSITIVE
SIPDIS

WARSH/AHMED/JOHNSON/SCHINDLER; SAN FRANCISCO FRB FOR
CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK
STATE PASS CEA FOR BLOCK
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/READE
USDOC FOR 4420
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN
TREASURY FOR EXEC - TSMITH, OASIA/ISA -DOHNER/BAKER/CUSHMAN
TREASURY FOR WRIGHT AND AMB HOLMER
TREASURY FOR SOBEL AND MOGHTADER
NSC FOR MCCORMICK AND TONG

E.O. 12958: N/A
TAGS: EFIN ECON EINV CH
SUBJECT: SHANGHAI STOCK MARKET: UP, UP, AND A BUMP: WHERE TO NEXT?

REF: A. 07 SHANGHAI 25
B. 07 SHANGHAI 325
C. 07 BEIJING 7554
D. 07 SHANGHAI 777

SHANGHAI 00000028 001.2 OF 003


This cable is Sensitive But Unclassified. For official use
only, not for dissemination outside USG channels or posting on
the internet.

1. (SBU) Summary: The Shanghai Stock Exchange (SSE) rose 97
percent in 2007, adding to its 130 percent gain in 2006. The
market was characterized by volatility and sharp swings.
However, at the close of business in 2007, two-thirds of stocks
listed were at historical highs and local investor confidence
over the mid-term remains high. Concern about the effects of a
possible economic downtown in the United States and the subprime
mortgage crisis contributed to a more than 20 percent drop in
the market's value from January 15 to 22 of 2008. Institutional
investors and market analysts outlook for 2008 were mixed with
some predicting a crash and others predicting gains of as much
as 50 percent. Retail investors remain convinced that the
Chinese Government will support the market's value during this
politically important Olympic year. End summary.

---------------------------------------------
Shanghai Stock Exchange Up 97 Percent in 2007
---------------------------------------------

2. (SBU) The Shanghai Stock Exchange (SSE), as measured by the
Shanghai Composite Index (SCI), closed at 5261 points on the
last trading day of 2007, 97 percent higher than on its first
day of trading in January 2007. This annual gain came on the
heels of its 130 percent gain in 2006 that was sparked by the
success of China's non-tradable share reform and investor
confidence. (Ref A) The SCI reached a record high of 6124
points on October 16, 2007.

3. (SBU) China's financial structure and over-liquidity were
major factors contributing to individuals investing in the
market despite the relatively high price to earnings (P/E)
ratios. Inflationary pressure, a real negative interest rate,
closed capital markets, and ongoing RMB appreciation expectation
led individuals with savings to invest them in the stock market
in record numbers.

4. (SBU) Volatility in inter-day trading of Chinese A-shares
increased in 2007 over 2006, most obviously in the second half
of 2007 with the market bouncing up and down from week to week.
Part of this increased volatility was in response to government
policies, such as the doubling of stamp tax on trades. (Ref B)
Other swings in trading were attributed to expected government
policy and personnel changes as well as the fact that many
retail investors still rely on the rumor mill for basic market
information.

5. (SBU) Following the all-time market high on October 16, the
market declined 20 percent over the following two months. By
the middle of December 2007, the SCI started to rebound and by
January 14, 2008 had once again passed through the 5500 point
barrier. Two-thirds of listed companies were at historical
highs. The average P/E ratio of stocks listed on the Shanghai
Stock Exchange on January 14 was over 60, and the average P/E
ratio for the small- and medium-sized company sector was 99.

-------------------------------------
2008: In Like a Bull, Out Like a Rat?

-------------------------------------

6. (SBU) From January 15 to 22, as international markets reacted
to concerns with the subprime mortgage crisis and the
possibility of weak economic performance in the United States,
the SSE also slumped by 22 percent with the SCI losing almost
1,000 points. Consulate contacts in Shanghai attributed this
slump to weak investor confidence and a reaction to the turmoil
on the Hong Kong Stock Exchange and other non-Chinese bourses.
Their concern is that a slowdown in the United States would
spread to China, slowing economic and corporate profits growth.


SHANGHAI 00000028 002.2 OF 003


7. (SBU) The January 22 SSE announcement that the "Bank of China
failed to make a statement on an important event so trading in
its shares will be suspended for all day on January 22," was
seen by investors as strong evidence that the Bank of China has
large, undeclared losses in its subprime mortgage portfolio.
This prompted a seven percent market sell-off on January 22.
Bank of China subsequently issued a statement that these reports
were "groundless" and trading of its stock resumed on January
23.

8. (SBU) SSE Deputy Director Chao Kejian told Econoff on January
23 that while concerns about the effects on China's economy of a
possible recession in the United States had "weakened" Chinese
investor confidence, the sell-off was also driven by local
factors. The People's Bank of China has been consistently
raising interest rates, prompting some casual investors to
increase their bank savings rather than invest in the market.
Also, demand for cash is especially high going into the Chinese
New Year season as it is traditional to give cash as gifts.
(Note: The Year of the Rat begins on February 7. End note.)
Investors are also holding off on putting more money into the
markets until after the National People's Congress annual
meeting in March as many expect major economic decisions and
announcements to be made in that legislative session, he said.

9. (SBU) Shanghai Academy of Social Sciences (SASS) Institute of
World Economy Deputy Director Professor Xu Mingqi told Econoff
on January 24 that it appeared that the SSE's bull market had
run its course. He expected that in 2008 the market would be
characterized by volatility, with swings up and down as
individual investors attempted to time the crash that Xu
believes is inevitable in the later part of this year. Many, if
not all, retail investors believe that the Chinese Government
will support the market until the August Olympics in Beijing.
As soon as it is no longer government policy to support the
market, it should settle down to a "more real level," Xu said.

--------------------------------------------- ----
Institutional Investors Outlook: Mixed, Uncertain
--------------------------------------------- ----

10. (SBU) Institutional investors' and industry analyst outlooks
on the SSE in 2008 are mixed. Some representative views:

-- Haitong Securities Company Director Wu Bing is pessimistic
about the market's future since he believes the market's growth
over the last two years has gotten too far ahead of the
companies' fundamentals. If stock prices remain about the same,
he expects that it will take at least two years for company
profits to rise to bring average P/E ratios down to a more
reasonable level.

-- Lombarda China Fund Manager Ian Midgely said that he does not
expect 2008 to be as "bumpy" as 2007 as there appears to be
government support for the market between 4800 and 5000 points.
As there are "currently no incentives for the government to have
the market unravel," Midgely anticipates that whenever the
market drops, there will be "favorable announcements" such as
approving the launch of new funds or other market-supporting
actions. He does not anticipate that the government will need
to take any direct measures to maintain stability.

-- CITIC Fund Management Company Business Development Senior
Vice President Peng Yan, noting the continuing over-liquidity
problem in China, expects that the market will continue to
advance in 2008.

-- SASS's Xu noted that since Chinese companies have only
started to issue dividends to their stockholders, individual
investors have traditionally had no way to benefit from holding
shares in a profitable company except by selling their stock at
a higher price than they paid. This means that the value of
Chinese stocks only goes up as long as more money flows into the
market, he said. Since there is a finite amount of money
available to be invested, this means that eventually there will
be a crash. He believes this crash is likely in 2008.

-- Shenyin & Wanguo Securities Company Manager Li Qinghai

SHANGHAI 00000028 003.2 OF 003


remains bullish. Stressing the high growth in corporate
earnings of listed companies, the positive effects of RMB
appreciation encouraging inflows into RMB-denominated assets
such as stocks, and the Beijing Olympics in August of 2008, he
expects the market to continue to advance.

--------------------------------------------- ---
RMB Appreciation, Inflation Both Good for Market
--------------------------------------------- ---

11. (SBU) SSE's Chao expects that the SCI will continue to climb
in 2008, but at a slower rate than in 2007. He said that SSE's
own analysis expects that the market could rise by as much as 50
percent in 2008. He attributes this sanguine outlook to several
"positive factors," including continued RMB appreciation and
inflation. The ongoing appreciation of the Chinese currency is
raising the value of Chinese assets and is directly leading to
increases on the stock market. Inflation (Ref C) is having a
similar effect as asset values increase so do the value of
stocks.

12. (SBU) Chao says that the stock market index futures product
will "definitely be introduced this year" and have a "negative"
influence on the value of the SCI. (Ref D) He expects that the
launch of the index futures product will "sharply affect the
market," and it is this concern that has led to its launch-date
being repeatedly postponed by policy-makers concerned about
retail investor backlash. The needs of institutional investors
to hedge their risks, however, mean that this futures product
must be launched eventually.
JARRETT

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