Forex Investment and Currency Trading

Equity market will continue to cool in 2008. The equity market may find a bottom having retraced its bull rally in 2007. But new share issuance and the sale of previously non-tradable shares may spur further declines.

The Shanghai Composite Index has fallen -36% this year, making it the worst performer in Asia. Next in line are India (-22%) and the Philippines (-18%). Domestic factors remain the main reason for the weakness. Indeed, correlations between the index and the Dow Jones are still the lowest in Emerging Asia at 0.30%. The equity market is responding to a combination of factors including: 1) large share issuance since late last year, for instance, a $3.2bn IPO by China Railways Company in February. 2) the sale of non-tradable shares following expiry of their lock-up period; 3) fears on economic growth and inflation after the Lunar New Year snowstorms; 4) capital losses earlier in the year have since spurred selling and further capital losses.

However, the equity market has almost fully retracted its 2007 rally, so the next few weeks are important to determining whether it will stabilize, or whether a more protracted fall is likely. Encouragingly, the China Securities Regulatory Commission (CSRC) said on March 28 it would more closely regulate new share issuance to prevent flooding the market. The retracement of last year’s bull rally may have also flushed out the majority of speculative positions. The risk to this view is if the sale of recently freed non-tradable shares accelerates from their current level.

It’s also worth taking a step back and recognizing that last year’s equity market rally followed a period of virtual stagnation, between 2002 and 2006, when real GDP growth averaged 10%. So, last year’s increase in prices in part reflected catch-up. A return to 2006 levels appears difficult to justify on the basis of the current robust real economic performance.