I don’t normally write so much about the stock market but today, like yesterday, the stock market seems to be at the center of events. Not unexpectedly the SSE Composite started the day badly after yesterday’s awful 4.5% drop to 3443. By midmorning it was down a whopping 2.6%, to 3355. Later in the morning, however, it partly recovered and then quickly gave it back again, until early afternoon, when it suddenly shot up in less than two hours to 3544, which is 5.6% off its lows for the day and 2.9% above yesterday’s close.
What caused this surge? The first thing to note is that although over 80% of the stocks traded up, the best performers by far were the large oil companies. Sinopec went up 10%, the maximum permitted by the Shanghai Stock Exchange in any one day. PetroChina jumped 6.6%. Those with suspicious minds have already noted that smaller oil refiners, like Shandong-based Taishan Oil, actually began the rally much earlier, trading up yesterday in spite of overall terrible markets. My finance-obsessed student Shang Ning tells me that electricity generators and coal companies also did very well, which is surprising because in China the electricity generators are forced to sell power at government-set prices but must buy coal at market prices, so that rumors of intervention or non-intervention in the coal markets tend to help one at the expense of the other.
What seems to have caused the sudden rally was a spate of rumors that the government was planning to lift price caps on refined oil products. Chinese oil companies are forced to sell refined oil products domestically at a fraction of the world oil price and, not surprisingly, this has really crimped profits. It has also led to hoarding, shortages, and smuggling.
The NDRC has been eager to deregulate oil prices, or at least to reduce the gap between world prices and domestic prices, but has been reluctant to do so up till now (the last price hike was, if I remember correctly, a 10% hike in October) because of the potential impact on inflation and inflationary expectations. Those who argue that Chinese inflation is largely a consequence of temporary food-supply shortages (the too-little-pork camp) are determined that until food supply comes back on line the greatest risk is that rising inflationary expectations lock China into a self-fulfilling cycle of rising inflation. China has aggressively implemented price freezes and tried to control rising prices so as to address the psychological impact of rising prices and prevent them from creeping into wages.
Those of us (the too-little-money camp) who believe that Chinese inflation is a monetary problem, caused by an inflating money supply – consequence of the forced purchase of capital and current account inflows by the PBoC – have never believed that price freezes will work. In our view they will simply cause inflation to shift to other goods and, in so doing, will distort demand in the market and encourage hoarding and shortages.
Either way, price freezes are expensive, and with food comprising so important a part of the consumer basket (officially 33% but probably much more), it seems that inflationary expectations may be forming anyway. Whether you believe inflation is caused by too little pork or too much money, at this point you have to be pretty pessimistic about the inflation trajectory for the rest of the year. Shang Ning told me yesterday that many of the local commentators who were effectively arguing two months ago that they expected average prices to peak in May and begin declining in June are now saying that they expect average prices to peak in September and begin declining in October. This is already at least the second or third time they’ve pushed back their expectations for the end of inflation – any bets on whether or not they will soon push the timing back again?
What is the likelihood of the rumors of a hike in oil prices being true? It is hard to say, but these rumors have been around for a while, and in China policy tends to emerge first as rumor and only later as policy. The fact that smaller oil companies shot up yesterday, and larger oil companies today, suggests that there are at least some who believe very strongly in the rumors.
What about the timing of a relaxation of the price freeze – given the recent devastating earthquake and the country in mourning, is it likely that the authorities would engineer a price hike now? Part of me thinks that there might be enough anger and economic disruption over the earthquake for this not to be a good time to raise oil prices, but on the other hand I think there are at least two good reasons for the government to go ahead and raise prices now,
First, the impact of the earthquake on food production (Sichuan is not important in industry but is fairly important in agriculture, and is in fact the country’s largest pig producer) may have ended the authorities’ hopes that food prices will come down soon enough to prevent a sharp increase in inflationary expectations. In that case it is probably better to adjust oil and other prices now, rather than have them continue to distort energy use and be forced up anyway at some point in the future – this is maybe a variation on the idea that you should release all the bad news immediately and then release the good news in batches, so as to create the illusion of continuous improvement.
Second, the earthquake has caused a huge outpouring of nationalist fervor and support for the government, along with fierce criticism of anyone deemed not supportive enough (one of my nicest students told me today that he has been criticized for wearing a brightly-colored shirt, which is considered inappropriate under the circumstances), so the government may believe that it is easier to raise prices and make other tough moves now.
If the rumors are really right, and oil prices are about to be hiked, it may be good for oil companies but I don’t expect the rest of the market should surge in sympathy. On the contrary other stocks should get hit. Any meaningful increase in oil prices is certainly going to push CPI up, and as it does it will put even more pressure on the PBoC and the financial authorities to tighten monetary policies. Remember that after the run-up in stock prices after the earthquake, it was the Thursday PBoC Q1 report, with its warnings of excess growth and the need to tighten, that caused the market to turn around and begin its more than 6% decline from its peak.