Nope, I’m not talking about my bladder as I remain pinned to my TV waiting for the twins to get naked on Big Brother. I am, of course, talking about the Chinese Stock Market. Anyone who’s not been stranded on Mars for twenty years will know that China is THE growth region of the world economy. And anyone who’s been following the markets will know that the Chinese Stock Market is looking somewhat like a bubble that is about to … yes, you guessed it …. burst.

The facts and figures are plastered all over the press at the moment but let’s have a quick recap anyway. In for a Fen, in for a Renminbi, as they say in …errr … somewhere or another. Anyway China’s broad stock market index, the Shanghai composite, has risen over 50% from 2,728 at the beginning of the year to a peak of 4,335 last Tuesday (29^th May).

Back in late February a rumour about the Chinese government clamping down on foreign share ownership caused the index to fall over 8% in one day. But in less than three weeks that fall had been recouped. And, with millions of Chinese people investing in Chinese shares (government rules prevent them from investing in shares overseas) the Chinese market was rising like a plate glass skyscraper into a clear blue sky. Until last Wednesday when the Chinese Government, worried about the possibility of a bubble, decided to dampen share prices by increasing stamp duty from 0.1% to 0.3%. On that day the market fell 6.5%. The following day produced a small rally but since then the Shanghai Composite has continued to fall. As of today’s close the index stands at 3,761, a whopping 13% off the highs of just a few days ago.

The upy-downy-ness of the market throws up lots of interesting questions. Such as is the Chinese stock market really in a bubble – or could the prospect of a country with a population four times that of the USA and growth that makes the Celtic Tiger look like a cute little kitten justify such share prices? If it is in a bubble will it burst now or, like the dot-com bubble in 2000, will we have months of volatility and some good buying opportunities before prices emphatically swing south? And given China’s enormous appetite for commodities what effect would collapsing share prices have on oil and metal prices?

But I like to think of myself as a feet-in-the-muck kind of guy and my question is far less lofty. My question is that, given Shanghai is around 6,000 miles away from sunny summery Dublin, should I give a s***?

The answer most people would give is yes, of course I should. Why? Well one reason is that the Chinese stock market jiggles and wiggles have been on the front page of the FT for 3 of the last 5 days. Which must mean it is important, right? However a more convincing answer can be summed up in one word: contagion.

Contagion is the effect of a sharp fall in the prices of one financial market knocking back the prices in other financial markets. One of the best documented examples of contagion is ‘Black Monday’ on October 19^th 1987. Falling share prices in Hong Kong followed daylight hours and triggered a drop in Europe which then moved on to cause heavy damage in the US. Once people saw the damage done in the US a second day of falling prices hit Asia, then Europe, and caused more selling in the US morning session before prices steadied in the afternoon.

Why the ripple effect of contagion happens is not especially well understood. The World Bank lists several possible causes including:
- leveraged international institutions (if such an institution has a leveraged position in country A and the stock prices in country A fall it may need to sell assets in country B in order to make sure it has enough money in the bank)
- herding behaviour (meaning investors base their decisions on the actions of other investors as well as on the information they revceive).

What is certain is that contagion occurs. And has occurred in almost every financial markets fall. Even the sell-off in Chinese shares in late February, mentioned way back at the top of this article, caused major falls in Dublin, London and the US. But here’s the punchline. The only recent exception to contagion (and isn’t there always an exception) is the current fall in the Chinese Stock Market. Contrary to my expectations and (I suspect) the expectations of most market watchers the reaction to a 13% fall in Chinese share prices has been … err … nothing at all. Even geographically close markets such as Hong Kong and Japan seem to be turning a blind eye while the S&P500 has set a record high.

Why? I haven’t the faintest idea. Answers on a postcard please … Some people have pointed out that, as Chinese rules prohibit much foreign ownership, the effects of contagion should be limited. But that does not explain why the 27^th Feb sell-off caused waves. Others have been shouting about the fact that this bubble has been pretty widely called. But then haven’t they all? Isn’t that why bubbles burst – because there are a significant number of people who reckon they are in a bubble and are ready to sell (or even go short) the moment they see a hint of trouble?

So do I give a damn? Not much. I’ve been following the goings on in China with quite some interest but they aren’t likely to affect my trading views. What it has done is remind me of two things:
– China is not the only market that has made spectacular rises recently – others, like Germany and Sweden, are much closer to home. And what goes up must come down. Eventually.
– No matter how long you’ve been trading and no matter how much thought you put into things, the markets can always surprise you. Which is why it’s better to trade what you see happening than what you think should be happening.

And on that wise note I shall leave you.

May the markets be with you, fellow jedis.