China’s equity bubble is going supernova

A supernova is a stellar explosion that is so bright it momentarily outshines the entire galaxy. The most massive supernovae are caused by stars which collapse under their own gravity, sending massive shockwaves radiating outwards into space.   Any onlooker happening to see a supernova might be forgiven for thinking that these super-bright objects are the most awesome stars in the sky — but that bright spot is just an epic final burst of remaining energy.    At their brightest moment, we are actually witnessing stellar death.


So… sell?

We think it’s a pretty good metaphor for China’s off-the-charts market indices.  In equity-market terms, a supernova is a blow-off top:   That moment when novice traders get suckered into thinking that today’s awesome growth is a sign of even higher future returns tomorrow.  The reality being that they are merely witnessing a final burst of energy — after which the future isn’t quite as bright, to say the least.

Here’s what’s happening in China:


We’ve all heard the stories of Chinese banana-sellers trading stocks from their fruit carts – and old, semi-literate Chinese peasants buying stocks in local Internet cafes.  And to be fair those stories do sound a whole lot like the “shoe-shine boy with a hot tip” who provided the contrary-indicator of legend to Joe Kennedy.   But that’s not what scares us about the China stock market bubble.  After all, if half-trained, inexperienced investors jumping into the market was in itself a sell-signal, we’d frankly never buy.   Dumb money makes as many booms as it does busts.  And as we all know, the so-called smart money isn’t half as smart as it often pretends.

Here’s what is scary though.  And should be scaring anyone who is paying attention:


Median P/E

Shanghai composite PE ratio

We’ve been here before.

P/E levels are now exceeding the insanity of the last bubble, and for those who remember:  It didn’t turn out so well.


Margin debt

Volatility here we come

Add volatility.  Stir.

Margin debt is also at record levels.   High levels of margin-debt typically correlate to markets at their peaks.   And while high levels of margin debt don’t necessarily increase the likelihood of a crash, they do amplify volatility and make crashes exceedingly more violent affairs.


Exports are down.   Imports have collapsed.

China’s exports are down for the third month in a row.  Down 2.5% YoY.  China’s imports have toppled 17.6%.   Hardly the stuff of economic boom-times.   While the economy seems to be going one way, equity markets are going the other.

And one must note that these falling metrics come on the back of last month’s PBoC stimulus measures.

As BBC reports:

Domestic demand in China continues to be weak despite stimulus measures by the government and central bank to boost growth.

The central bank had lowered interest rates just last month, which was the third time in six months to spur lending and economic activity.


Freight is collapsing

China’s containerized freight indexes have collapsed, with shipping to South America and the Mediterranean leading the plunge.

No small move

No small move


And the big metrics tell the same story:

As the South China Morning Post reminds us this morning:  (emphasis ours)

China’s gross domestic product expanded 7.4 per cent in 2014, the lowest rate in nearly a quarter of a century and there have been few signs of a pick-up this year.

[China's] GDP expanded 7 per cent in the January-March period, the worst quarterly result in six years.


While a change in rate does not necessarily indicate a change in vector, we’re having an enormous amount of difficulty seeing a setup for justifiable further equity-market enthusiasm.   That having been said, no one knows how long a supernova will last.


One more thing about Supernovae

One of the interesting dynamics of supernovae is that as they explode into giant balls of light,  there’s something happening in the background that’s not visible to the observer:   The actual mass of the star inside shrinks.  That gigantic burst of energy that we see actually conceals an underlying contraction.

We’ll leave the parallel to you.



  • Peter T

    Buy buy buy! Don’t miss out!

  • Winter is Coming

    Perhaps afterwards China will be a “red dwarf”. Rather fitting don’t you think?

  • Up and Away

    But who’s to say it won’t double first before burning out? Who cares if freight is collapsing? Let it collapse another 50%. Equity markets are a separate entity. They can separate from fundamentals for years.

  • ThenewStorky