Lunar 2008 may be year of bear in China markets Stocks may fall as inflation, not Olympics, tops economic agenda By Moming Zhou, MarketWatch Last update: 7:17 p.m. EST Feb. 11, 2008 Editor's note: Updating to correct the spelling of Alan Greenspan's name SAN FRANCISCO (MarketWatch) -- Chinese stock markets have been closed since Feb. 6 as investors welcomed the Year of the Rat, but when markets reopen Wednesday, analysts fear it might become the year of the bear. In the past lunar year, the benchmark Shanghai Composite Index plunged more than 20% from its peak, and some expect the government to shore up markets ahead of this summer's Beijing Olympics. But those who assume the government won't let the markets fall ahead of the games may be disappointed. Chinese investors' hopes that the government will step in to support sagging stock prices "reminds me of the Greenspan put," said Robbert van Batenburg, an analyst at global equity broker Louis Capital Markets LP. Batenburg was referring to U.S. investors' legendary expectations that the Federal Reserve under Chairman Alan Greenspan was always ready to bail out investors by easing interest rates. But it would be risky to bet that such a "put" is going to come through in China, where the government's focus is firmly on the domestic economy, especially inflation, Batenburg said. "Although the appreciation of the stock markets is welcome by the government, it's not their priority," Batenburg added. "Their priority is to generate about 10% of economic growth, to absorb the urbanization, and to maintain a benign and peaceful social environment." To be sure, the government does come up with market support steps from time to time. On the second-to-last trading day of last lunar year, China's Shanghai Composite Index surged more than 8%, after the nation's stock market regulator gave its approval to two funds to raise up to 14 billion yuan ($1.95 billion). But "it's very hard for any authority or any entity to manipulate any market for a longer period of time," said Batenburg. Further government actions could also be limited as the government turns its priority to battling inflation and trying to keep its still red-hot economy from overheating. As the markets turn lower, global investors could see the value of their Chinese stock portfolios shrink in the year of Olympics. As the U.S. economy veers toward recession, emerging markets are not necessarily a guaranteed alternative. Inflation trumps Olympics Contrary to many people's expectations, this summer's Olympics Games will have little impact on China's overall GDP growth, "due to the sheer size of the Chinese economy," said Ting Lu, an economist at Merrill Lynch, in a recent research note. Inflation, not the Olympics, will be the keyword for China in 2008, Lu said. China's inflation reached 4.8% last year, the highest in nearly 11 years. Paces of price increases are likely to accelerate in 2008 after the recent deadly blizzards. The storms could have pushed inflation to as high as 7.2% in January, and 5% to 6% in the first half of the year, according to Minggao Shen, an economist at Citigroup. "The government should be focused on three things this year inflation, inflation, inflation," said David Riedel, president of overseas equity-market specialist Riedel Research Group. Most analysts expect the government to fight inflation by tightening macroeconomic and monetary policies. Merrill Lynch recently revised its China interest rate forecast to three hikes this calendar year from two hikes, with China's one-year benchmark deposit and lending rate seen rising to 4.95% and 8.01% respectively. Real deposit rates, which have long been negative, will be brought into positive territory in the second half of 2008, according to Merrill, a factor that could give individual investors less incentive to move their savings to the equity markets. Further rate increases could also put more pressure on China to allow its tightly controlled currency to appreciate faster against other major currencies. That, as well as a possible U.S. recession, could weigh on the country's exports, which account for nearly 40% of its gross domestic product. Time for a correction? The Chinese government is more interested in an orderly correction in the stock markets than in supporting the markets artificially, said Riedel.
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