China stock market - Fear or Flock

At this in time, global investing is not easy for the casual investor. The highly digestible "BRIC" strategy was a godsend for many who wanted managable risk, high returns and a dash of global exposure to offset a reliance with passe Fidelity Blue Chip America. Watch out though, as the "C" is about to lose it capitalization, in both grammatic and value terms. "BRIc" will be a less valuable strategy, in other words. The China stock exchanges are valued more than double their global counterparts, meaning that investors are forecasting that in the next 5 years or so, Chinese companies will double today's profit. I read that China shares are trading at a 46 P/E compared to about 20 in developed markest. This screams "internet 2,000 A.D." to me, with the admittable difference that China is actually making stuff, and the internet bubble really did just produce air.

Possible? Perhaps, but consider that the average, Chinese retail investor has likely been responsible for this valuation in the expectation that the economy will prosper for a long, long time. Once the first member of the herd departs, two more will join, then four, and before long expect chaos. Chinese investors are no different from naive and unexperienced investors anywhere in the world. They get hot tips from cab drivers and hair stylists and drive the market up. But ask them to fill in the blank for the simple question "A ____ flow statement describes operating, investing and financing activities" and I think you get a blank stare. That expressionless face scares me more than Hannibal Lecter's.

In good times, you rarely hear tough questions. Pre-bust Enron was an analyst darling. Post-bust, we hear all the right questions being asked. Times in China are so good, good, good that we're going to look dumb for not asking them. 50% of GDP going to capital investments, while developed markets spend 20-25%? Surely a lot of the cash is going into zero return projects like apartments, malls and roads that are underutilized. Banks are lending the money out with a wink and handshake instead of a positive review of a business plan. And until this year why haven't the stock markets grown at the rate of capital investment growth plus ROI? The cash is all going somewhere and the stock market smells green. I think the bubbling is not from a latent buildup of returns being unleashed in the market, but simply from exuberance. As the average person paid for the internet bubble, so the average investor will be paying for the China stock market blow up.

What I really don't know is what the knock on effect will be around the world. There's a subject for future blogs. Now go sell your BRIC.