In today’s letter, without the backdrop of the trading day and tick-by-tick analysis and news frenzy, I want to build on a thread started in Thursday’s letter by Evan Cooper related to China. In his piece on Thursday, titled, Lessons From Three Crashes, Evan noted, the “Chinese speculative bubble can’t go on forever…”, I’m going to drill into that.
Let’s dive in.
Quick Facts: China's Markets
When you start to drill into what’s going on over in China’s markets, you quickly re-discover a few facts that combined, are pretty scary really.
Here they are:
- At $14.2T (fluctuating on where the market is at, of course) in dollar terms, China’s market’s are huge, the total of which equates to “two Nadsaqs” in terms of capitalization
- China’s market’s are heavily traded by investors, on an average day 3% of shares change hands, that is 10x the NYSE’s 0.3%
- As Howard Gold at MarketWatch points out, China’s market is quite easily argued to be in a secular bear market (defined as a long term down trend with periods of up trend) given the fact the most recent run-up of the Shanghai market, which cresting at 5,000 earlier this year, failed to eclipse the 2007 (8 years ago!) high of 6,000
- Margin (money borrowed to invest in the market) is up 5x since one year ago and 9x since two years ago
So far, although relatively concerning, this is not the most concerning part about what’s happening in China right now.
From The Desk of: Are You Kidding Me?
As we drill into #5, it’s hard to layer on the critical, judgemental, astounded, flabbergasted (or scared?) tone too much when addressing the next, cannot-be-missed chapter in the ongoing saga of the Chinese government intervention in it’s market—and remember, we’re saying that after seeing The Fed’s balance sheet balloon from $865,453,000 on July 8th, 2007 to $4,481,289,000 on July 8th, 2015 a 5.2x increase in a span of eight years less a month, or 95 months).
In plain english, as of July 2nd, you can use your home as collateral for your margin account tied to the stock market.
“The China Securities Regulatory Commission will allow brokerages to accept new forms of collateral, including real estate, from clients with insufficient value in their stock accounts.
The regulator, which cut short a public consultation on the rules due to “market conditions,” said investors no longer need to supply extra collateral within two days when it falls below 1.3 times the amount of borrowed money. The new guidelines let brokerages give six-month extensions to clients’ margin trading and short selling contracts, instead of liquidating the positions.”
Betting The Farm
In digging into the latest Chinese stock market convulsion I can’t seem to shake two things: first, by all accounts, the Chinese market is fueled by speculators; the heavy trading volume, the massive retail component, the fact there is no legal “gambling” option for most in mainland China—parlayed with the qualitative undertone of the comments from Asian based analysts who note “momentum” as a preferred strategy vs. “value”, for example. The most cynical observer would equate a strictly “momentum” strategy as “buy high, sell higher” with a the greater fool theory. This well known theory’s upshot is that rather than assets being priced based on intrinsic value, they’re priced based on the (current) buyer believing there will be a new buyer at a higher price, fundamentals be damned. This is the foundation of almost all bubbles.
The second thing I can’t shake is that the Chinese government seems to be attempting to be the greatest fool of all in this escalating game. And that’s scary.
We’ll be keeping a close eye on exposure to these ongoing events across our portfolio and watch lists in an effort to mitigate risk as required.
Thanks and talk to you on Monday as we’re set for another eventful trading week with the Greek drama coming to a head and likely further volatility in China’s markets, not to mention some important earnings here at home set to come down the pipe.