Still Draggin' Dragon

I watch China's Shanghai stock market through the eyes of a Westerner, even though China's
capital controls keep the participation of offshore money in its market limited. The real
estate markets are the bigger plays in China, and I believe many of the locals use a rising
stock market as a stepping stone for capital accumulation to play the various real estate
sectors.

I downgraded the market early in the year because I felt faster rising wage and materials
costs would pressure corporate profit margins. However, indications are that with strong
productivity gains in tow, profits growth has remained healthy. The market has fared poorly
this year anyway. The p/e multiple has been contracting, and from a Westerner's perspective
this development reflects accelerating inflation in China as well as efforts by the gov. and the
PoBC to trim asset speculation and inflation via a tightening of monetary policy and of
capital flows.

Viewed longer term, I regard the Shanghai Composite (11/26 2872 close) as reasonable
at the 3000-3200 level. With China a high growth economy, I use a 10% compound return
off the extended late 1990s base of around 1100. As the chart link ahead shows, the market
has been exceptionally volatile and has not often traded neatly in line with a 10% price
progression ( long term SSEC chart).

The market did recently come out of a year long downtrend, but has been buffeted in recent
weeks by additional gradualist credit tightening moves by the gov. The market is in a short
term downtrend, but there is no clear signal yet that the downtrend will extend and deepen.
The market is trading very near trend support, so a critical moment for direction could be
at hand. It is very hard to call turns with this market and it is much better to be a trend
follower when trading (shorter term trend).

The inflation momentum that has built up in China is significant and could require further
tightening steps including more deposit rate increases before authorities decide they
can ease up some on the tightening reins.