Since last year, China’s shares have been correcting very steeply. Ok Arugably, they were very expensive at the top, but since the economy is still growing at 10% a year, time is on the bulls side, right? First, let’s look at the chart of the last 3 years, it’s quit a chart.

That’s a heck of a correction! Epic proportions, looks like Nasdaq 2002 or Nikkei 1994..

But surely, with the economy still growing around 10% a year, that must come to an end sooner rather than later, right?

An other argument one hears is that great impetus coming from the Olympic Games. We’re not so sure. There must be considerable output loss from those closed factories and couple of million cars that are not allowed on the road to clean up the air.

However, having said that, there is something more important going on. And it’s not good. Another impact of the Olympic Games was that in order to acquiescence the population, food prices have been kept low artificially (perhaps the one thing that’s really ‘communist’ about China, apart from having a one party state), and subsidies on fuel have increased enormously.

This could easily be reversed after the Games, and higher food prices and lower fuel subsidies could add substantially to the inflation figures, which so far, have behaved in a rather more benign fashion compared to many other big (or small) developing countries.

For instance, in India, inflation has increased from around 7% to almost 12%, while in China has decreased from almost 9% to 7% in the same time period. That’s odd, considering what’s been happening on the world markets.

If lower fuel subsidies and higher food prices add a couple of point to headline inflation, the central bank could very well have to increase interest rates. Inflation could very well end up in double digits. Higher interest rates is not good news, neither for the economy (which is already under some stress from slowing export growth) nor for stocks.

Exports are under pressure from:

• A slowing world economy (US, Japan, EU, all flirting with recession)
• An upward trend in the Chinese currency
• An upward trend in relative Chinese labour cost

It doesn’t look like they’re going to resume their upward trend anytime soon, however, there is something in the graph above that might suggest otherwise. To have a better look, let’s take the last three months:

Could it be that a triple bottom is forming? That 2600 level better hold, otherwise Chinese shares will lurch downward again..