The Shanghai Tower and Aftermath: New Update
Note from dshort: After publishing my latest Shanghai Composite look back, I received an email from Michael in Sweden asking "Shouldn't the Shanghai chart be in real prices (inflation adjusted)? I guess it would even be more symmetric."
I've updated the commentary below to accommodate the suggestion with an additional chart.
Of late market watchers in the U.S. are wondering if the QE3 stimulus will have a comparable effect on markets as the first two rounds of easing. And of course we in the US are nearing the end of the third quarter with earnings season just over the horizon. Around the world the ongoing euro zone financial crisis remains in the center ring of the world's financial circus. But what caught my eye this afternoon in doing my weekly world market update was the ghastly performance of Shanghai Composite.
My friend and occasional guest contributor Chris Kimble came up with the notion of an Eiffel Tower formation as an emblematic way to discuss asset bubbles, which was featured in a guest commentary from last summer. The behavior of the Shanghai index over a two-year period beginning in late 2006 is a classic example, as the first two charts illustrate.
With an arithmetic vertical axis, the Eiffel analogy is rather amazing.
Here is the same chart, this time adjusted for inflation using the OECD's Consumer Price Index: All Items for China, which is available in the St. Louis Fed's economic data repository here. I've chained the index price in CNY currency as of June 2012. The difference for the bubble years (late 2006 to late 2008) is rather subtle.
But let's switch to a log scale vertical axis (nominal prices) and shorten the timeframe to look at the numbers. We diminish the playful tower analogy, but we get a more accurate visual representation of the relative values of peaks and troughs in the price.
The horizontal red line shows the current level of the index. At Friday's close the index is down 7.85% year-to-date and over 66% off its 2007 all-time high.
Where is this index headed in the near to intermediate term? The ongoing economic turmoil in the eurozone, China's biggest export market, continues to be a significant problem, and signs of a slowing domestic economy are exacerbating the problem. However, over the next few years, Chinese demographics should provide a bit of cushion.
In developed countries, the peak earning years are ages 45-54, with the 45-49 cohort as the peak spenders. Assuming China is moving toward a similar pattern (an assumption I make with caution), the earning-spending cohorts will grow significantly. Unless China's housing bubble triggers a widespread retrenchment and a loss of consumer confidence, demographics, at least over the next 5-10 years, should work in China's favor, driven by home-grown consumption.
One thing is certain. We'll want to keep a close eye on the Shanghai Composite in the months ahead.