China: Not for the faint-hearted

16th June 2010

China has never been a market for the faint-hearted.

Try to forget everything you've heard about how a country that's expanding by 8% a year can't possibly fail to make you rich, and focus instead on the incredible volatility that the stock market has displayed over the last decade.

But, above all, forget entirely the idea that strong economic growth translates smoothly and inevitably into steady investment growth.

China is an emerging financial nation with poor market liquidity, a hefty dependence on imported commodities, and a government that sometimes makes very, very large policy decisions at the drop of a hat.

As the chart below shows, the correlation between economic growth and stock market performance is more than tenuous, it's non-existent.

We know that first-quarter GDP in 2010 was up by 11.9%, and even the most modest projections for 2010 as a whole are currently running at nearly 10%, to be followed by an expected 8% next year.

And we know that industrial production was up by 18% year-on-year in April.

Yet the Shanghai Composite stock, which is partially dollar-denominated, dropped by nearly 20% between January and mid-June – a period when the economy was supposedly growing by around 5%.

Either the markets have got it wrong, or else the experts can see something that isn't obvious.

So which is it?

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