High Speed Crash

The recent Crash of 2 high speed trains in China is not only a reminder of the danger of building a high-speed railway network in high speed without proper management, but also a reflection of vulnerable situation of Chinese economy and the corresponding political system.

One of the lessons learned from the crash is that when the speed is close to the limit, it’s dangerous. In addition, paying the high price for that kind of speed is also not worth it. Having learned the lesson, the Chinese government adjusted the speed limit of the high-speed train and the corresponding prices lower. However, many investors or speculators of the stock market in China don’t seem to learn the same reasoning behind.

The shanghai stock exchange composite index (SHCOMP:IND) is now hovering around 2500. Many people think that the market is bottoming. “How much can it go lower?” is the typical question. The reason behind is the history record of the index at 6000 in 2007 and at 3000 in 2009. While I am not a fortune teller of any stock market index, I am quite sure that the growth of the Chinese economy will not be as fast as the past decade and it’s dangerous to keep that speed. Therefore, the lower index is just a reasonable reflection of slower economical development in near future and the risk of slowing a high-speed economy . I am not sure whether 2500 is the bottom of the market and I don’t care. By looking at the valuation of companies (except banks, real estate developers, and related companies), they are mostly projected at high growth rate (at 30% growth for the next 5 years or even faster). Although the profit growth of these companies looked healthy for the 1st half of the year, the corresponding operation cash flow growth in the same period was mostly negative on large scale with accounts receivable increased dramatically. It’s an obvious signal of slowing down for these companies and the current prices based on high growth projection are not sustainable. Further more, the capital expenditures of these companies are very high comparing to their net incomes, leaving owner earnings very low or close to zero. The growth of such companies are actually supported by capital expenditures, which is a simulation of the whole economical development of China at large.

On the other hand, the prices for banks and real estate companies look cheap based on their recent reports. However, nobody can really estimate the potential risks of the bad loans from local government and the bubble of real estate market. The current low prices of these companies are reflecting such risks.

In all, the prices of listed companies in the China stock market are not cheap in general. The crash of the high-speed economy may not actually happen. But to avoid a crash at such speed gracefully is also a difficult mission, if not possible.