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courage is contagious

Viewing cable 08SHANGHAI28, SHANGHAI STOCK MARKET: UP, UP, AND A BUMP: WHERE TO NEXT?

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Reference ID Created Released Classification Origin
08SHANGHAI28 2008-01-24 09:18 2011-08-23 00:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Consulate Shanghai
VZCZCXRO9767
RR RUEHCN RUEHVC
DE RUEHGH #0028/01 0240918
ZNR UUUUU ZZH
R 240918Z JAN 08
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6620
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7151
UNCLAS SECTION 01 OF 03 SHANGHAI 000028 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
WARSH/AHMED/JOHNSON/SCHINDLER; SAN FRANCISCO FRB FOR 
CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK 
STATE PASS CEA FOR BLOCK 
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/READE 
USDOC FOR 4420 
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN 
TREASURY FOR EXEC - TSMITH, OASIA/ISA -DOHNER/BAKER/CUSHMAN 
TREASURY FOR WRIGHT AND AMB HOLMER 
TREASURY FOR SOBEL AND MOGHTADER 
NSC FOR MCCORMICK AND TONG 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV CH
SUBJECT: SHANGHAI STOCK MARKET: UP, UP, AND A BUMP: WHERE TO NEXT? 
 
REF: A. 07 SHANGHAI 25 
     B. 07 SHANGHAI 325 
     C. 07 BEIJING 7554 
     D. 07 SHANGHAI 777 
 
SHANGHAI 00000028  001.2 OF 003 
 
 
This cable is Sensitive But Unclassified.  For official use 
only, not for dissemination outside USG channels or posting on 
the internet. 
 
1. (SBU) Summary:  The Shanghai Stock Exchange (SSE) rose 97 
percent in 2007, adding to its 130 percent gain in 2006.  The 
market was characterized by volatility and sharp swings. 
However, at the close of business in 2007, two-thirds of stocks 
listed were at historical highs and local investor confidence 
over the mid-term remains high.  Concern about the effects of a 
possible economic downtown in the United States and the subprime 
mortgage crisis contributed to a more than 20 percent drop in 
the market's value from January 15 to 22 of 2008.  Institutional 
investors and market analysts outlook for 2008 were mixed with 
some predicting a crash and others predicting gains of as much 
as 50 percent.  Retail investors remain convinced that the 
Chinese Government will support the market's value during this 
politically important Olympic year.  End summary. 
 
--------------------------------------------- 
Shanghai Stock Exchange Up 97 Percent in 2007 
--------------------------------------------- 
 
2. (SBU) The Shanghai Stock Exchange (SSE), as measured by the 
Shanghai Composite Index (SCI), closed at 5261 points on the 
last trading day of 2007, 97 percent higher than on its first 
day of trading in January 2007.  This annual gain came on the 
heels of its 130 percent gain in 2006 that was sparked by the 
success of China's non-tradable share reform and investor 
confidence. (Ref A)  The SCI reached a record high of 6124 
points on October 16, 2007. 
 
3. (SBU) China's financial structure and over-liquidity were 
major factors contributing to individuals investing in the 
market despite the relatively high price to earnings (P/E) 
ratios.  Inflationary pressure, a real negative interest rate, 
closed capital markets, and ongoing RMB appreciation expectation 
led individuals with savings to invest them in the stock market 
in record numbers. 
 
4. (SBU) Volatility in inter-day trading of Chinese A-shares 
increased in 2007 over 2006, most obviously in the second half 
of 2007 with the market bouncing up and down from week to week. 
Part of this increased volatility was in response to government 
policies, such as the doubling of stamp tax on trades. (Ref B) 
Other swings in trading were attributed to expected government 
policy and personnel changes as well as the fact that many 
retail investors still rely on the rumor mill for basic market 
information. 
 
5. (SBU) Following the all-time market high on October 16, the 
market declined 20 percent over the following two months.  By 
the middle of December 2007, the SCI started to rebound and by 
January 14, 2008 had once again passed through the 5500 point 
barrier.  Two-thirds of listed companies were at historical 
highs.  The average P/E ratio of stocks listed on the Shanghai 
Stock Exchange on January 14 was over 60, and the average P/E 
ratio for the small- and medium-sized company sector was 99. 
 
------------------------------------- 
2008: In Like a Bull, Out Like a Rat? 
 
------------------------------------- 
 
6. (SBU) From January 15 to 22, as international markets reacted 
to concerns with the subprime mortgage crisis and the 
possibility of weak economic performance in the United States, 
the SSE also slumped by 22 percent with the SCI losing almost 
1,000 points.  Consulate contacts in Shanghai attributed this 
slump to weak investor confidence and a reaction to the turmoil 
on the Hong Kong Stock Exchange and other non-Chinese bourses. 
Their concern is that a slowdown in the United States would 
spread to China, slowing economic and corporate profits growth. 
 
 
SHANGHAI 00000028  002.2 OF 003 
 
 
7. (SBU) The January 22 SSE announcement that the "Bank of China 
failed to make a statement on an important event so trading in 
its shares will be suspended for all day on January 22," was 
seen by investors as strong evidence that the Bank of China has 
large, undeclared losses in its subprime mortgage portfolio. 
This prompted a seven percent market sell-off on January 22. 
Bank of China subsequently issued a statement that these reports 
were "groundless" and trading of its stock resumed on January 
23. 
 
8. (SBU) SSE Deputy Director Chao Kejian told Econoff on January 
23 that while concerns about the effects on China's economy of a 
possible recession in the United States had "weakened" Chinese 
investor confidence, the sell-off was also driven by local 
factors.  The People's Bank of China has been consistently 
raising interest rates, prompting some casual investors to 
increase their bank savings rather than invest in the market. 
Also, demand for cash is especially high going into the Chinese 
New Year season as it is traditional to give cash as gifts. 
(Note: The Year of the Rat begins on February 7.  End note.) 
Investors are also holding off on putting more money into the 
markets until after the National People's Congress annual 
meeting in March as many expect major economic decisions and 
announcements to be made in that legislative session, he said. 
 
9. (SBU) Shanghai Academy of Social Sciences (SASS) Institute of 
World Economy Deputy Director Professor Xu Mingqi told Econoff 
on January 24 that it appeared that the SSE's bull market had 
run its course.  He expected that in 2008 the market would be 
characterized by volatility, with swings up and down as 
individual investors attempted to time the crash that Xu 
believes is inevitable in the later part of this year.  Many, if 
not all, retail investors believe that the Chinese Government 
will support the market until the August Olympics in Beijing. 
As soon as it is no longer government policy to support the 
market, it should settle down to a "more real level," Xu said. 
 
--------------------------------------------- ---- 
Institutional Investors Outlook: Mixed, Uncertain 
--------------------------------------------- ---- 
 
10. (SBU) Institutional investors' and industry analyst outlooks 
on the SSE in 2008 are mixed.  Some representative views: 
 
-- Haitong Securities Company Director Wu Bing is pessimistic 
about the market's future since he believes the market's growth 
over the last two years has gotten too far ahead of the 
companies' fundamentals.  If stock prices remain about the same, 
he expects that it will take at least two years for company 
profits to rise to bring average P/E ratios down to a more 
reasonable level. 
 
-- Lombarda China Fund Manager Ian Midgely said that he does not 
expect 2008 to be as "bumpy" as 2007 as there appears to be 
government support for the market between 4800 and 5000 points. 
As there are "currently no incentives for the government to have 
the market unravel," Midgely anticipates that whenever the 
market drops, there will be "favorable announcements" such as 
approving the launch of new funds or other market-supporting 
actions.  He does not anticipate that the government will need 
to take any direct measures to maintain stability. 
 
-- CITIC Fund Management Company Business Development Senior 
Vice President Peng Yan, noting the continuing over-liquidity 
problem in China, expects that the market will continue to 
advance in 2008. 
 
-- SASS's Xu noted that since Chinese companies have only 
started to issue dividends to their stockholders, individual 
investors have traditionally had no way to benefit from holding 
shares in a profitable company except by selling their stock at 
a higher price than they paid.  This means that the value of 
Chinese stocks only goes up as long as more money flows into the 
market, he said.  Since there is a finite amount of money 
available to be invested, this means that eventually there will 
be a crash.  He believes this crash is likely in 2008. 
 
-- Shenyin & Wanguo Securities Company Manager Li Qinghai 
 
SHANGHAI 00000028  003.2 OF 003 
 
 
remains bullish.  Stressing the high growth in corporate 
earnings of listed companies, the positive effects of RMB 
appreciation encouraging inflows into RMB-denominated assets 
such as stocks, and the Beijing Olympics in August of 2008, he 
expects the market to continue to advance. 
 
--------------------------------------------- --- 
RMB Appreciation, Inflation Both Good for Market 
--------------------------------------------- --- 
 
11. (SBU) SSE's Chao expects that the SCI will continue to climb 
in 2008, but at a slower rate than in 2007.  He said that SSE's 
own analysis expects that the market could rise by as much as 50 
percent in 2008.  He attributes this sanguine outlook to several 
"positive factors," including continued RMB appreciation and 
inflation.  The ongoing appreciation of the Chinese currency is 
raising the value of Chinese assets and is directly leading to 
increases on the stock market.  Inflation (Ref C) is having a 
similar effect as asset values increase so do the value of 
stocks. 
 
12. (SBU) Chao says that the stock market index futures product 
will "definitely be introduced this year" and have a "negative" 
influence on the value of the SCI. (Ref D)  He expects that the 
launch of the index futures product will "sharply affect the 
market," and it is this concern that has led to its launch-date 
being repeatedly postponed by policy-makers concerned about 
retail investor backlash.   The needs of institutional investors 
to hedge their risks, however, mean that this futures product 
must be launched eventually. 
JARRETT