Stock bubble in China is bursting: Stephen Roach

Stephen Roach's bull case for China
Stephen Roach's bull case for China   

Bargain hunting after the plunge in Chinese stocks would be like "catching a falling knife," former Morgan Stanley Asia Chairman Stephen Roach said Tuesday, after returning from a trip to China.

Chinese stocks were volatile again overnight, but closed well off session lows, as investors remained doubtful of the efficacy of Beijing's recent market rescue measures.

"The bubble is bursting," and predicting the bottom is anyone's guess, Roach told CNBC's "Squawk Box." He added, however, that China's efforts to transform its economy remain unchanged, which he views as "good news."

The Shanghai composite rocketed more than 80 percent higher over the past 12 months in what Roach called an "enormous speculative frenzy."

Since hitting a seven-year peak of 5,166.35 on June 12, the market has fallen about 27 percent—triggered by a host of factors, including an unwinding of margin trading and concerns over lofty valuations.

Despite the recent rout, the Shanghai composite was still 15 percent higher for the year as of Tuesday's close.

"The market was underperforming when the economy was booming. And the market surged as the economy was slowing," the Yale University senior fellow said. "The bottom line on China, and I picked this up loud and clear in travel there over the last month, is this model shift from manufacturing-led exports ... to service-led consumer demand [economy] is something they are continuing to emphasize."

China is also trying to address its debt-to-gross-domestic-product ratio, which some estimates peg at more than 225 percent, Roach said.

"[But] they don't have a full array of capital markets to support the economy, like places like the United States," he continued. "So they have to rely on much more debt financing to grow this investment-led economy. They went too far, especially in the property area."

Still, Roach said the Chinese economy will stabilize around 6.5 percent to 7 percent growth. "It's not going to go to zero as some of the China bears" have predicted, he said.

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