China's White-Hot Stock Market Is Getting Slammed

China shanghai stock exchangeREUTERS/Aly SongPeople look at an electronic board at a Shanghai brokerage house.

China’s stock market is open, and it’s getting slammed. The Shanghai Composite is down by almost 2% in early trading.

Still, this is just a tiny pullback in what’s been an eyepopping rally.

Ever since the People’s Bank of China unexpectedly cut its benchmark interest rates on November 21, the Shanghai composite has been going bonkers, surging a whopping 18%.

“Equity bulls have benefited from a perfect storm of positive conditions,” Bloomberg’s Tom Orlik wrote on Friday. “Policy easing has boosted optimism about growth, lower oil prices raise profit expectations, and the Shanghai-Hong Kong connect promises to bring more funds onshore.”

“The trouble is that none of those factors are quite as positive as they seem,” Orlik cautioned. He notes that GDP growth expectations have been stuck at 7% and the Shanghai-Hong Kong connect has been disappointing with trading flow quotas not being met.

So, what’s going on here?

Orlik attributes the recent surge to retail Chinese investors piling in.

“A sustained rally since the middle of the year appears to have lured many back into the market, evidenced by the pronounced rise in trading accounts,” he wrote.

The folks at Bespoke Investment Group put together the chart below overlaying the Shanghai Composite with the creation of Chinese brokerage accounts. The correlation is compelling.

Unfortunately, this is likely to end badly, Orlik says.

“China’s retail investors have an unfortunate track record of jumping in at the top of the market,” he wrote. “A 2011 survey conducted by Gan Li, an economist at Texas A&M University, found that just 22 per cent were up on their investments, compared to 56 per cent who had made losses and 22 per cent breaking even.”

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