Shanghai Bubble Finally Bursting?

As I have mentioned before, the Shanghai Stock Exchange has had one of the biggest bubbles in history over the last two years. The SSEC index has gone up from a low of 1067 on 28 October 2005 to a high of 6124 on 16 October 2007, an increase of 474% over less than two years!

Click the graph for a larger version.
Since then it has declined to close at 4861 on 27 November. Is this drop of more than 20% the popping of the bubble, or just another false alarm? There have been two previous big scares for Chinese investors this year, the first one in February-March, the second one in June-July, but the Shanghai Stock Exchange recovered from both of them and kept on chugging upwards. However, this latest drop is bigger (percentage-wise) than any of the previous two. If it continues, we could very well see one of the most epic stock market crashes in history.

Internet Bubble Version 2.0

Don't think the Internet bubble of 1999-2000 scared all investors away from hyperinflated Internet stocks. I'm thinking of for instance Google, currently trading at $660 per share. Alright, down a good bit from the top of $742 two weeks ago, but still dizzyingly high at a price/earnings of about 52. This means that if they manage to keep their earnings as high as now and give all of their earnings back to their shareholders (which they of course don't), it would take about 52 years for a shareholder to get his money back in dividend. Now, what if earnings start dropping, with a recession coming on? Other Internet bubble stocks right now are Amazon, with a price/earnings of about 93 (!) and Yahoo, with a price/earnings of about 50. Price/earnings this high of course means that the markets expect the earnings to increase, but just how many more advertisers want to advertise with Google or Yahoo? Or are they going to pay more for advertising there? And how many more books and CDs can Amazon sell per year? Or are they going to take higher profit margins on each sold book?
For comparison, Microsoft and Cisco both have a p/e of 22, which is still considered to be on the high side. How long would you like to wait to get your invested money back? 22 years? Make that 10 and it starts to sound like a reasonable investment.

Shanghai Still Chugging Upwards

The recent turmoil in the financial markets worldwide does not seem to have hit the Chinese. The Shanghai Composite index keeps on rising and is now at 4955, which is a gain of nearly 400% over the last two years. Has the world ever seen a more obvious stock market bubble? There was a bit of a scare in February, when everybody thought the Shanghai stock market would crash and drag the world along with it. Since then it has gone up by about 70% more! Even when global markets have plunged over the last few weeks, the Shanghai stock market has kept on chugging along upwards, after a bit of a wobble in June and July.

When is this house of cards going to come down? Nobody knows - many analysts have been calling a top since the beginning of this year, but Shanghai keeps on ignoring these warnings. But when it does come down many Chinese investors (big and small) will learn the hard reality that stock markets can actually crash. What effects this eventual popping of the Chinese stock bubble will have is hard to predict, but be sure that they will be big in some way. The Chinese do everything in a big way - the Great Wall, the Three Gorges Dams, and so on.

Stocks over Time

With the recent turbulence on the stock markets, many people are wondering if they should keep their money invested in stocks and mutual funds. The mainstream advisors all say something like "investing in stocks is always good in the long run". This has been true during the period 1982-2000. However, it has not been so for other time periods. Someone who invested $100 on the US stock market in 1929 did not get his money back until 25 years later, in 1954. If you invested in the stock market during the spring of 2000, you didn't get your money back until 7 years later, this summer of 2007. And what has inflation done to that money during those periods? Definitely not good investments I would say. Although the very long trend of the stock markets has been up from 1901 to 2007, there have been long periods where the long trend has been sideways or down. Adam Hamilton explains it well in his article Long Valuation Waves.

If you look at the Swedish stock market the long trend from 1950 to 2000 looks like it went more or less up all the time. Here is a graph of AFGX (Affärsvärldens generalindex) 1950-2006.
However, if you look at the graph adjusted for inflation, the picture is quite different.
As you can see, the Swedish stock market actually went down from 1965 to 1980, if you adjust it for inflation. Not until 1982 did it come back to the same level as 1965. This means that during this period of 17 years, stocks were not a good investment in the long run. As you can see we have also gone more or less sideways 2000-2006 too (first down and then up). I'm convinced we've now entered another 17-year period when stocks are not a good long-term investment. As Adam Hamilton says in his article, these bear market periods have historically been about 17 years long. The latest bull market of 18 years from 1982 to 2000 also fits in very well with these long cycles.

The problem now is that most people giving financial advice at banks and in the media don't remember these long waves, since most of them have started working after 1982.
They have read about these long bear markets, alright, but most of them seem to think we're living in a new age where these long waves don't exist any more. So far all expectations for a "new financial age" have been brutally hammered down, in 1929 as well as in 2000.