My Blog

May 20, 2008

The stock market seems to be getting increasingly worried about the economic impact of the earthquake, even though Sichuan province comprises just 4% of China’s GDP production and most of Sichuan’s most developed areas, including its capital Chengdu, were left relatively unscathed.  Still, it seems that uncertainty has increased in a variety of areas and investors don’t know how to respond.

Part of the reason may be because of the quake’s potential impact on fuel and food stocks.  Sichuan is a big agricultural producer (I think I read somewhere that it is the most important province in China for producing pork), but it seems likely that it is going to be a net drain on food supplies for at least the next few months, rather than a net provider.  This of course will prolong the period of food scarcity and make it harder for food prices to come down. 

The quake may also make fuel shortages worse, thus increasing pressure on the authorities to let fuel prices move a little closer to world prices.  According to today’s Bloomberg, Sinopec “has diverted gasoline and diesel supplies from southern and coastal regions to quake-hit Sichuan province and lifted rationing on fuel sales as the recovery effort boosts demand.”  According to the company newsletter, the nation's biggest oil refiner has cut back on supplies to Hunan, Hubei and Guangdong.

The stock market trade up 0.4% last Monday, the day of the earthquake.  It dropped 1.8% the next day as we began to get the first indications of its severity, only to shoot up 2.7% by Wednesday, as investors began expecting a big fiscal and monetary push in response to the earthquake. 

The stock market started Thursday also very strong, but the release late that morning of the PBoC’s Q1 report, ended the party.  The PBoC’s report suggested that excessively high levels of investment and monetary loosening were still a problem, and although they tried to sound positive on inflation, it was clear that they were worried about hot money inflows and rising prices.  This report seriously damaged expectations that the PBoC would be forced to loosen considerably in response to the earthquake, and the market closed down 0.5% for the day.  It lost another 0.4% Friday, and then continued dragging down by another 0.6% Monday.

Today, however, the market took a real beating.  It started the day relatively strong, trading up 0.8% in little more than an hour, but after that it was all downhill.  During the last hour of trading the market moved into panic mode, trading volume surged, and prices dropped steeply, handing investors a 4.5% loss for the day.  My student Shang Ning tells me that with a very few exceptions (some highway and cement companies based in Sichuan or nearby Chongqing) all sectors of the market were badly hurt. He ends his market roundup with: “I feel the market is now without ideas and very afraid of the effect of the earthquake.  Not many investors want to play in the markets now – everyone seems just to want to watch and see what happens.”

The market is now at 3443, about 15% above 3000, which many investors believe is the minimum level below which the government does not want to see the market go. Remember that on April 22 it broke 3000 for a few minutes, and within two days the government announced the reduction of the stamp duty, setting off a rally which drove the market up by over 25% over the next few days to close, on May 5, at 3761.

Given the huge attention being placed on the rescue effort and the fact that most media are discouraged from reporting anything but positive images of the rescue efforts, it is hard to know what exactly is going on in the market and in the minds of the authorities.  Obviously their number one concern must be the rescue effort, although by now there is little hope that we will find additional survivors.  Still, the PBoC and the financial authorities must be monitoring the stock market closely and they must be working overtime to figure out just how much slack they have for fiscal and, more importantly, monetary loosening. 

They must also be worried that today’s market collapse could so harm investor sentiment that within a few days we return to striking distance of 3000.  I discussed in my May 6 entry (“Perceptions of market support can add shocks”) that one unfortunate consequence of an investor perception that a major player will intervene to support prices at a certain level is that the market can drop very sharply if the support level is ever breached.  We now have the risk that if we continue to see several more very negative days so that the 3000 level is tested, it may be difficult for the government to know how to respond while we are still in the midst of the earthquake crisis.

Comments (5) for "The effect of the earthquake...

The China stock carnage today is indiscriminate. Be it the earthquake damage or national mourning, the mood supported the drop, but the pace prior to market closing exuded deep sense of fear and panic,usually unsustainable. The only saving grace today is the lower volume traded compared to the preceding up days. Though higher than past two days, both of which were down days, it ranked 7th lowest in volume of the 9 down days we had since the rebounce started 3 weeks ago. I wish that renders today just as a panic day, with the fear subsiding from tomorrow, but a down day is still a down day and market can easily drop more for many days with decreasing volume. By kelaido - 5/19/2008 8:58 PM

Authorities always have good memories, the first few fund managers who voliated the game rules yesterday will surely pay for redemption anyway. What FED did in 911 is a close lesson for mangement to follow, it won't take them long to responde if the market continues to drag down. propoganda and research paper will surely be ulmostly used to relieve investors' scary, directional advise would be given to few market players, banking sector and real estate sector stocks would be largely supported (though they are not overvalued anyway). bolder measures would be taken by authorities if the market refuse to responde positively. By andy huang - 5/20/2008 9:23 AM

Andy, the government's measures to slow the market on its way up and prop it up on its way down have not been terrible effective and have seemed less and less effective over time. There still are a lot of people in China who really do believe that the market and the economy responds to the government's intentions, but I think this belief is getting eroded as it becomes clearer that there is little they can do. I suspect that there will be some attempts to push up the market today, and it might even work for a few days, but I am not sure I would believe too strongly in it. By Michael Pettis - 5/20/2008 2:27 PM

Michael, thanks for your reply. As a regular reader of your blog, I share your opion on that government shouldnot intervene the market too frequently. As the more they do so, and the less credibility of the government policy become. yet I suspect they will quit the market volunteerily. firstly, they themselves are the benificiary of a sound stock market (personally or institutionally); secondly, each major market downturn will reshuffle the nation wealth distribution which evidently will threaten the social security. politically and economically they cant' afford the loss. on the other side of the story, chinese people tend to believe the government will bail them out which happens to be the exact image the party wants to build. whether or not intervene the market is not even a dilemma for the government. the question is always how and to what degree. One way to bail themselves out is to develop bond market. that way will decrease the capital market's volatility substantially. As a direct benificiary of sound bond market, I am happy to see that day come soon! By Andy huang - 5/20/2008 3:20 PM

Credit Suisse must pick a day after Shanghai Stock Comp index dropped 4.5% to publish their forecast of SSEC to drop another 25% by year end, and the market responded today with a dramatic reversal that surely confounded even more skeptics and believers. The bulls staked their claims loudly today, but combined with the effect from yesterday, the bears still have the upperhand, until tomorrow. By Kelaido - 5/20/2008 6:14 PM