Hot air balloon

I rode in a hot air balloon once and was taught that anything you could walk away from was called a landing. The Chinese stock market is giving its passengers just such an experience.

We believe that the Chinese economy will overtake the US to become the number one in about 17 years from now. But we also think that getting there will be a very bumpy journey.

The Shanghai Composite Index topped out in 2008 at 6124. It fell 73% to the lows in 2008 and has now fallen back 32% again.

In a bear market we always look for a special shape on the charts of a fall, followed by the rally, then the rest of the fall. We are clearly into the last leg of this pattern. Watch out below. Once on the ground again we will be able to concentrate on getting the next flight together.

While this hard landing is going on in China, it is the other markets in the region that are scoring well in our table.

Thailand, Indonesia, Singapore, Malaysia and the Philippines are all in the strongest part of the ranking order.

The top part of the table is likely to continue to be dominated by either the Pacific or Latin American regions and usually these markets move in a homogenous way. But the odd one out has been China. It got completely separated from the pack by the Olympic games. The valuation at that time was so excessive that a fall had to take place.

There is a good chance that the excuse for a meltdown into the October lows will be the hard landing in China. Also, the reason for a subsequent rally will probably be the next massive stimulus package from the US. It is important to remember that the market is going to do what it has to do anyway. All these explanations are just so that the media has something to talk about.

Right now the priority is the need to survive a hard landing. Do not break a leg. All other plans are on hold.

David Fuller's view Valuations were a problem for China before the Olympics but I think heavy supply in the form of IPOs has been an even bigger weight on the mainland's stock market (p&f, weekly & daily) than valuations, the squeeze on property speculation and a slight slowdown in GDP growth.

This chart of the historic p/e for the Shanghai Composite Index shows that investors have been rewarded for buying when the p/e has fallen below 20.

Given that China's GDP growth rate over the next twelve months is likely to be in the 8 to 10 percentage range, the forward p/e will be considerably lower. Some strategists estimate that it is in the 10 to 12 range, which represents very attractive value for a high-growth stock market. Looking at the charts above, I think there is a reasonable chance that China's stock market index bottomed in early July, near the upper side of the first step above its small base formation.

Since I am in general agreement with much of Robin Griffiths' report it is easier to cite what I disagree with. He is more bearish than I am because I think the chances of another 10 to 15 percent slide on Wall Street from current levels are less than 50/50. Consequently, I am not contemplating any further selling within my personal long-term equity portfolio, although I may continue to open the occasional hedge trading short in a choppy environment. However, I agree that this is often a period of seasonal vulnerability; technical damage to most OECD country stock markets has occurred since the April highs and this may require further support building before the next significant advance occurs.