China Note

As discussed back in Dec. '12 and in early Jan. I argued that a recovery in the Shanghai
stock market was well overdue based on an easy money policy and the fact that the
economy had started to expand again. Following a super fast run-up that kicked off in
early Dec. '12, the market went nearly vertical until mid-Feb when word started to get
around that the economy was slowing. Then, another body blow came today when the
cabinet leaders imposed new restrictions on real estate investments including higher
down payments and capital gains taxes on sales of a variety of properties. Real estate
equities tumbled and pulled the market down. Moreover, since the Chinese use the
equities market as a way to try and build capital to play in real estate, speculators were
forced to take some money off the table.

Measured yr/yr, China's money M-2 has increased by more than 20%. No "pushing on a
string" here. The economy has responded positively and the large block of excess liquidity
has been finding its way right into the property markets. The official data on the economy,
as suspect as it may be, show that the Peoples Bank has been providing liquidity well in
excess of the needs of the real economy for at least a decade. The authorities have been
playing "catch up" with year after year of new regs to contain wild cat real esate markets.
Since the PBOC has been a steady fount of excess liquidity, the authorities, who are pressed
to provide housing for a fast growing work force, have obviously allowed the central bank
vast leeway to fund real estate development whether silly (the "ghost cities") or sensible.

The Shanghai market was overbought and due for a correction which it is getting now.
The risks to the market concern whether the authorities are dead serious this time about
curtailing real estate speculation, and more conventionally, whether China's recent ramp
up in output was a little strong relative to sustainable export demand.

The real estate game as funded by excess liquidity allows the authorities to create a small
army of mandarin buddy tycoons as well as fund needed development. So, it may be that the
new chiefs and the PBOC may stay with aggressive monetary policy until it finally shows
up in the inflation rate.

In the meantime, it is early to tell whether China over-ramped production for the short run.

My view of the Shanghai remains that it can trade up to 2700 if the economy can maintain
real economic growth in the 7% per year range. Obviously, getting there may not be a smooth
ride. Shanghai Composite