Shanghai 180 index SSE180

A potentially important observation on China from Professor Scott Reamer, featured today on the Buzz & Banter…

My firm recently analyzed the Shanghai 180 index (180 largest market cap weighted Chinese A-listed stocks) via our complexity framework. In effect, what we are able to conclude is that since beginning of December, the Shanghai index is within an unstable, critical regime that has a high probability of failing in a large way. In fact, the Shanghai index is showing ~70% of the unstable criticality that the NDX displayed in its run up to its 2000 peak. Thus we can expect a very large drawdown to start in this index in the next several weeks.

Why is this potentially interesting to US investors?

Recently, the Chinese monetary and banking authorities have been bloviating about margin concerns and speculation in the markets. And in a command economy, those very authorities are likely to be the precipitating exogenous crisis for the Shanghai index even as the endogenous market risks (as measured above via the complexity framework) increase to some critical state very very quickly. And not to be dismissed is the contagion potential in such globally correlated markets to say nothing about the implications for global GDP and the cynical vendor finance-relationship that the US and China enjoy. If the Chinese stock market suffers a 50% + decline in 2007, what are the likely policy responses (yuan intervention, credit availability, US treasury demand from PBOC, etc.)? And what impact would such a decline have on their appetite to hear more posturing from senators Graham and Schumer or from Mssrs Bernanke and Paulson?

From a macroeconomic standpoint, we can be reasonably certain that the real pool of funding (real liquidity as defined by the Austrian school of economics) here in the US contracting meaningfully (which is another way of saying that the malinvestments – housing, e.g. - pursued over the years are large and growing as the result of easy credit policies). Simultaneously, the Chinese (or more broadly the non-Japan Asia) real pool of funding is relatively healthy; and why the US has not yet experienced a significant credit cycle bust is owing to the fact that we are largely living off this real pool of funding from Asia. To the degree that the Chinese economy experiences a systemic financial shock (and the Shanghai index getting cut in third or in half would certainly qualify), their appetite or ability to keep "bankrolling us" with their real pool of funding comes into serious question. Thus, the Shanghai index might be this particular credit cycles canary insofar as it could precipitate the long overdue credit cycle contraction that has eluded global G7 asset markets and the US economy for the past several years at minimum.

The SSE180 index is now down 12% since Tuesday and 4+% overnight again. Like a monkey knife fight, speculating on this particular economic/political maelstrom has a lot of potential entertainment value. Unless it's your monkey.


R.P.