Lately the biggest action in stocks is coming not out of the US, where the 4 month old melt up is on its last fumes, but out of China, where the marginal liquidity has now dried up, leading to such explosions of concern as 7 day SHIBOR going asymptotic (a topic discussed earlier). Some readers have expressed a concern as to just how credible RRR and interest rate hike actions are as relating to the performance of the Chinese stock market. Well, a look at the recent action in the SHCOMP for one should serve as a good basis for a starting opinion. A far better one, and stretching back a decade, was recently conducted by Nomura, which presents the following must see chart which shows how toothless the PBoC is when it has to deal with already latent massive liquidity excess. Specifically, during the 2006-2007 bull market, the PBOC had to hike interest rates 7 times in a row, and increase the RRR over 10 times before the market topped out in late 2007. Which begs the question: just how impotent is the PBoC in sequestering excess liquidity (remember: Bernanke can do it in 15 minutes), and are its tangential actions of boosting liquidity far more relevant when it comes to the MSCI China Index? Last but not least, the PBoC can merely control domestic liquidity directly: it is well known that foreign inflows into China refuse to abate. It is precisely this that the Chinese central bank should be (and probably is) dead set on intercepting if it wants to prevent food price riots (recall our prediction for a rice bubble).
Continued ‘unexplained’ foreign capital inflows following US quantitative easing have expanded the PBoC’s money base, leading to more liquidity. Renminbi appreciation expectations should further fuel such inflows, we believe. Our economics team forecasts four more interest rate increases and three RRR hikes during the course of 2011. We think there will also likely be more administrative measures, including loan quota controls. Whereas the RRR hikes earlier this year came as a surprise, we believe the market is now prepared for more RRR hikes in 2011. Any price weakness stemming from an initially negative reaction to these would likely present a buying opportunity, in our view.
In the aftermath of this report, the PBoC hiked its interest rate once (Christmas Day 2010) and had 2 separate RRR hikes. It will likely have many more. We believe this means that the SHCOMP likely has far more downside from here... and sooner or later this liquidity collapse will migrate to the chief source of all liquidity bubbles: the good old US of A.