Submitted by Experience Not Logic Blog

A couple of Financial Times articles today got me thinking about the Shanghai Composite Index, Bubble Trouble and Shanghai shares soar as tax cut takes effect.

Way back in May of ‘07 Beijing took action to try and cool the market by introducing a stamp tax on trades. Despite the tax, the Shanghai Index remained one of the best performing markets in the world with prices increasing 141% from February 2007 to October 2007. At the peak on October 16, the average price/earnings ratio was at over 50x. By Tuesday, April 22, 2008, the Shanghai Index had fallen 51.2% to a 13-month low. But, P/E was at a less volatile and much more reasonable, and still a little bubbly 20. Something had cooled down the market. Probably the state of the global financial markets and overspeculation in worthless assets, but regardless the market was cooled to stable level. Why would Beijing intervene to jack the market up if it is operating more like (but still considerably dissimilar to) a normal market?

The FT articles speculate that the reduction of the stamp tax sparking a 9.3% jump in the Shanghai Index “betrayed an unwarranted nervousness about market movements.” Long-term investors have no problem posting gains, but small investors are hurt considerably from declines in the market and the government is stepping to help them. Also, the articles speculate that “with the Olympics approaching, Beijing would prefer the stock market to be rising again as it showcases the results of its rapid economic development.” A strong market is a nice indicator of a strong economy despite one of the articles noting that the performance of the Shanghai market has little impact on the “real economy” of China.

The “Bubble Trouble” article ends with the following wisdom:

[I]ntervention [by Beijing] will merely ensure that volatility remains a feature of the Chinese equity markets. Investors will revert to basing decisions not on the underlying value of the shares they want to buy or sell but on their guesses about the intentions of the Chinese government. Perhaps they were right all along about the destructive embrace of the state, the stock markets and the Olympics.

Also, see Michael Pettis’s insightful posts on this subject for some in depth and original analysis:
Stock market rises 9.3%
Stock market is down today