It's not all gloom for the market

Liang Hongfu

2007-11-27 15:27:11  China Daily      

Stock markets abhor uncertainties, and the outlook for 2008 is anything but cloudy.

At the time of writing this column, the price of oil had breached the $99 a barrel level to a shade below $100 and the US subprime mortgage trouble was showing signs of worsening. These were the main factors cited in the latest Federal Reserve's report which projected a sharp slowdown in economic growth to between 1.6 percent to 2.6 percent, compared with the previous forecast range of 2.5 percent to 3 percent.

Nobody is saying that the US is heading toward a recession. But some economists were quoted by the US media as saying they believed the Fed's projections could be overly optimistic.

A significant downturn in US economic growth could have predictable repercussions in many Asian markets. Last Wednesday after the Fed's report was published, Tokyo plunged nearly 2.5 percent and Hong Kong lost a whopping 4 percent.

The mainland stock market, which has remained largely immune to international fund flow, also dropped nearly 3 percent on that day as institutional investors, like their counterparts in other markets, reportedly were having a hard time digesting the mix of economic data. Thin trading on the mainland bourses last week suggested that many investors were sitting tight while waiting for the global economic drama to unfold.

The stage is set for the December 5 OPEC meeting when major oil producers will decide whether to increase output to help stabilize world oil prices. This would be a tough call as some leaders of oil producing countries were already complaining that the commodity was undervalued as a result of the depreciation of the US dollar against most other major world currencies.

The mainland stock market boom in the past year or so was largely fuelled by what economists called the reallocation of assets, which is the transfer of money from low-yielding bank deposits to share investment. For that reason, the spectacular rally was mainly backed by hard cash, or, as we Hong Kong people like to say, "yellow gold, white silver", not bank credit.

To be sure, the scale of asset reallocation may have slowed as the ballooning stock market has already absorbed a much larger share of the aggregate financial assets than before. But the specter of a stock market bubble about to burst seems to have been vastly exaggerated in some of the most recent analyst reports from foreign investment houses. Margin calls that can turn a cyclical stock market retreat into a rout are unlikely to happen on the mainland's relatively low-leveraged investment environment.

Investors' confidence seems to have remained unshaken by the stock price decline in the past week. But without any form of hedging mechanism, some institutional investors, including many newly established mutual funds, may find it necessary or desirable to realize gains or cut losses now by unloading at least part of their holdings. This could trigger a snowballing effect, drawing more and more investors into the selling spree.

At times like these, many economists are calling for speeding up the preparation for the launch of index futures trading, which would provide an effective tool for institutional investors to manage their risks. Despite the uncertain outlook, we believe there will be enough people to bet that the setback is only temporary and the stock market rally will resume when the pressure on oil price increase begins to ease after the winter and the US subprime mortgage problem is contained.

At least there is one relatively safe bet: the Chinese economy will continue to grow at a brisk pace in 2008.