Increased IPO activity shows all was not well in Shanghai
The recent performance of the Shanghai Stock Exchange has been amazing and frightening.
It clearly shows that financial bubbles can occur even when there are clear warning signs and plenty of historical evidence to help identify bubble characteristics.
These warnings include asset price appreciation, trading volume, new issues and margin debt or borrowings.
One of the remarkable features of the Shanghai Stock Exchange was its stability between 2010 and the end of last year. The 2014 year index close was 3235, which was close to the 2010 year high of 3307.Advertisement Advertise with NZME.
But the market began to pick up last November and the Shanghai Composite Index rose 10.8 per cent during the month on trading value of US$797 billion. This compared with trading values of less than US$300 billion a month during the first half of the year.
The market really took off in December, when the index soared 20.6 per cent on trading value of US$1.8 trillion.
The start of this year was also frantic, particularly between March and May, when the index soared 39.3 per cent, with an average monthly trading value of US$2.5 trillion.
During this period the Shanghai market was the world's busiest stock exchange by a wide margin. Its trading value was 1.8 times that of the New York Stock Exchange (NYSE) and 2.4 times that of the Nasdaq.
Usually, it is the other way around - Shanghai had only 0.3 times the NYSE trading value in 2013 and 0.4 times the Nasdaq trading value over the same period.
The benchmark Shanghai Index soared 162 per cent from its March 2014 low to a high of 5178 on June 12 this year.
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Meanwhile, the number of IPOs went from zero in 2013 to 43 last year and 66 in the first five months of this year.
Increased IPO activity is a clear sign of an overvalued market, particularly when many of the new listings are of low quality as they were in New Zealand in the mid-1980s.
Reports from China indicated that recent new launches have been overhyped, the quality of the new issues has been low and unsophisticated investors have been major participants in the new issues market, both before and after listing.
There has also been a huge increase in margin debt - buying shares with borrowed money.
Official estimates show this represents 8.5 per cent of the Chinese sharemarket's free float, compared with margin debt of less that 3 per cent of the New York Stock Exchange free float.
Chinese commentators believe that margin debt is much higher than 8.5 per cent.
The Chinese Government and other official agencies have introduced a number of initiatives to stop the sharemarket slide.
Scheduled IPOs have been cancelled.
A large number of stocks have been suspended from trading.
The state-owned investment organisation Central Huijin has bought exchange traded funds and will continue to do so.
Chinese state-owned enterprises have been ordered not to sell shares and to buy oversold stocks.
Large brokerage firms have created a fund to invest in the market.
The People's Bank has provided liquidity support to China Securities Financing Corporation which will use this money to fund brokers offering margin debt.
Qualified insurers may now invest up to 10 per cent of their total assets in a single blue chip company compared with 5 per cent previously.
These moves are encouraging but the Chinese Government should never have allowed the market to get so overheated in the first place.
Margin debt was strictly regulated and almost non-existent in China until 2010. These margin debt rules have been substantially relaxed over the past five years and this has been a major contributor to the Shanghai market's meteoric rise and enormous trading volumes.
Margin debt has been the root cause of a large number of sharemarket booms and busts over the past 100 years.