China’s Canary In A Coal Mine: Shanghai Index Down 65%

December 31, 2008 by Douglas A. McIntyre

China_2The Shanghai Composite, which measures the combined share value of most of the large public companies in China, fell 65% this year. Among the major US indices, the sharpest drop was the 39% plunge in the Nasdaq. The Dow Jones Financial Index, which should have done as badly as any stock measurement in the world, was off 55%.

One of the most popular adages on Wall St. is that stock markets trade based on what investors think will happen to the economy and corporate earnings during the next six months. If that is true, the movement in the Shanghai Composite is ominous. It has dropped 20% in the last 90 days. Over that period, the DJIA is down only 12%.

There is still a significant debate about how bad the economy will get in China. Most of the signs are not encouraging. GDP, factory output, and exports are slowing. There is a school of thought that China is "too big to fail." It exports too many goods to nations around the world. Some of those countries will not do so badly in the downturn. China’s middle class consumes a large portion of what the economy produces, helping overall growth numbers. If GDP in the world’s most populous country keeps moving up that middle class and its wages will keep rising.

The other potential path for China’s future is based on a simple premise which is that the global recession will become so deep that it will crush demand for almost all goods and services. China’s exports will contract causing GDP to falter. Unemployment will move to levels which have not been seen in modern China. The middle class will begin to disappear. There are already anecdotes about workers getting on trains and bikes and moving back into rural areas where they can find work.

If the Shanghai Composite is any indication, China is in for plague which the nation has never experienced.

Douglas A. McIntyre