It’s tempting to compare China’s stock market of today to the Nasdaq Composite of the late 1990’s. Chris Perruna wrote an interesting post on it the other day and caused me to think about the validity of these comparisons. As a technician, I have a great respect for the repetitive nature of human behavior and how those patterns appear / reappear in financial markets. However tempting it may be to overlay charts and see amazing similarities to past events, it is also a very narrow analysis and one that could lead to very dangerous consequences if it is the primary basis for making an investment decision.

So to see the chartist point of view - click here to review the work that Chris has done. It’s good stuff.

Okay, so we can all agree that the first half of the Bubble-period Nasdaq Composite (”COMP”) looks eerily similar to the Shanghai Stock Exchange Composite (”SSEC”). Furthermore, I don’t think it’s a stretch to acknowledge that there is a bubble over there. But that’s where I am going to diverge and provide an alternative view. The dangers in comparative analysis are heightened when we only look at the similarities and then extrapolate a similar ending. Instead, we must look at the differences as well and when we do that, we still need to avoid the expectation that the ending will follow previous examples.

In no particular order of importance, consider the following:

• The SSEC has been around since 1991 while the COMP was started in 1971.
• The investors in the SSEC are primarily limited to Chinese nationals while the COMP was open to investors from all over the world.
• SSEC investors have minimal alternative investment choices while COMP investors had a full range of choices available to them.
• The SSEC has 832 companies (A shares) in it while the COMP had 4832 at the end of 1999.
• The sector diversification of the SSEC includes communication, property, utilities, conglomerates, and industrials while we all know the repetitive phrase about the “Tech Heavy Nasdaq.”
• China’s economy is quasi-capitalist / partially communist while the COMP is representative of capitalism.
• The dollar trading volume of the SSEC is significantly smaller than the COMP at the end of 1999.
• The market capitalization of the SSEC is significantly smaller than the COMP at the end of 1999.
• The SSEC PE ratio is now over 50 but the COMP had a PE of almost 200 in 1999.

The chart overlay tells one part of the story. Of course, markets are much more complex than just looking at a chart. All the factors I mentioned and many others I have not discussed make the market. The chart is just a composite image of them and by only focusing on a picture we oversimplify everything else that is going on. The Nasdaq of 1999 had many conditions that made it what it was. The Shanghai Composite of today has many other conditions that make it what it is. Most of them are very very different than the Nasdaq of 8 years ago. In fact, other than the similar charts, there aren’t many things that the two have in common.

The Chinese government has recognized the bubble they have forming but despite numerous efforts to slow things down, it has not worked. If you could identify the one thing or any series of things that precipitated the bursting of the Nasdaq bubble and tried to duplicate them in China tomorrow, there is no guarantee that it would result in a decline. As we know, bubbles are great until they are popped and we just don’t know when that will occur. Obviously, the duration of the upward move in China could last for much longer than the Nasdaq did in 1999 and if that happens, then the overlays will no longer look comparable. And even if it turned downward with similar timing, there is no guarantee that the retracement will mirror the decline of the Nasdaq in either its percentage change or rate of change.

Technical analysis is a great tool. Playing with charts is fun, but it’s important to trade the chart that you have and consider all the other factors that make it what it is. Trying to trade a chart you have by looking at a chart you don’t have, is dangerous. I wouldn’t make a new entry into China’s stock market but then again, I have been saying that for over a year - a year in which the SSEC has gone up about 200%. I believe the Chinese stock market is a bubble and I wish I was in it. I suspect that the liquidity issues, the lack of investor experience, the dominance of small retail investors over institutional holders, and all the other factors mentioned earlier will make the end of their bubble very painful. Will the chart of the decline mirror the pain we felt on the Nasdaq? I have no clue.