You’ve probably heard on the news about the stock market correction in China. Last year, Chinese stocks experienced huge gains and surged more than 140%. Oh my Buddha, that’s insane! 😯 But since June 2015, the market has dropped by almost a third in value. Some people in the media claim this is some sort of catastrophic event comparing it to the Great Depression.
But we know better. 😉 First of all, a 33% drop, after a 140% gain is not such a bad thing. In fact that’s a net positive return of 60% in about 18 months, so who’s complaining? 🙂 Secondly, due to strict foreign investment regulations only 1.5% of all the stock market shares in China are owned by foreign investors like Canadians and Americans. So this recent market decline has very little direct impact on investors outside of China. And lastly corrections inevitably happen after a parabolic upward trend, so this shouldn’t be a surprise to any informed investor. “Those who cannot remember the past are condemned to repeat it.” ~George Santayana
The Boom and Bust of China’s Stock Market
It all started a couple years ago when the Chinese government wanted to boost the country’s economy. It implemented policies making it easier for retail investors (average folks) to invest in the stock market. Things worked out even better than expected and the market quickly became detached from the fundamentals of the underlying economy. Last month the Shanghai Composite Index (SSE) started to fall. To make things worse many investors were investing on margin and had been forced to sell their stocks as their shares lost value which only perpetuated the downward momentum. 😕 Within a few weeks the SSE had dropped almost 33%. Here’s a comparison of stock markets over the last 12 months. (blue line = China, red line = Canada, yellow line = U.S.)
Recently China’s government put in measures to prevent further market sell-off by capping short selling, and encouraging investors for the first time to use their homes as collateral to borrow money to buy more stocks. Wait. Say what? Chinese investors have lost about $3 trillion (more than 10 times the entire GDP of Greece!) in the stock market since June 12 because the system had been too leveraged. How is giving people access to even more leverage now a good long term solution? If the real estate market also corrects then investors won’t just lose all their stock market investments, but quite possibly their homes as well. 😐
The Fallout
Earlier this year some financial experts warned China’s stock market might be in a bubble. What was their first clue, that the stock market value more than doubled in 2014? lol. The new policies to restore investor’s confidence seem to be working though as the SSE rose 5.8% yesterday, and another 4.5% today ending the week at 3877.80 points. That’s a 10% increase in the stock market over the last 2 days. That’s too much volatility for me. If that happened to North American stocks my net worth could make $50,000 swings every week, lol. No thanks.
The Takeaway
There are some indirect effects we’ll probably see from China’s stock market decline. If the country’s demand for commodities fall then Canadian exporters will see a decrease in profitability. This is already starting to happen as the price of oil is down 10% over the last week. Sorry Alberta. 🙁
I’m not predicting the SSE will continue to fall, but I wouldn’t be surprised if it reverted back to between 2,000 and 3,000 points. That means mining and other natural resource stock on the Toronto Stock Exchange could face further challenges. But overall it’s not a big deal as long as we have diversified portfolios. The stock market correction in China has the potential to become a major global financial problem, but for now it’s just gravity taking effect of an overvalued market so it’s all good. I would keep an eye on it but there’s no reason to rush for the exit or make any changes to our long term financial plans. 🙂
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Random Useless Fact
There was an extensive NYT article about the recent correction. I hadn’t read it, but my uncle had mentioned he learned that it is now illegal for people to discuss the possibility of stock prices decreasing …
That’s too bad. It sounds like a lame censorship policy that might backfire and make people even more anxious to sell lol.
“So this recent market decline has very little direct impact on investors outside of China.” ~ On stock holders… Plenty of investors rely heavily on China’s economy, even if they don’t know it. Foreigners may not feel an immediate financial impact of the recent decline, but dependent on what fiscal manoeuvres the Chinese gov’t takes/imposes, the bite could still be coming down the pipe. “Recently China’s government put in measures to prevent further market sell-off by capping short selling…” ~ Gotta love those times when we discover the “free” market is anything but. “…and encouraging investors for the first time to use their homes as collateral to borrow money to buy more stocks.” ~ Smith Manoeuvre, anyone? “SSE rose 5.8% yesterday, and another 4.5% today…That’s a 10% increase in the stock market over the last 2 days. That’s too much volatility for me.” ~ Um…almost all (~80%) of the largest modern day Dow and S&P single-day point gains (5-10%) have happened since 2008. Perhaps it’s only “too much volatility” when it happens to someone else’s market. “If that happened to North American stocks my net worth could make $50,000 swings every week, lol. No thanks.” ~ What does it matter?… Read more »
All great points. The western style quick fix works for some but are leaving many others behind. You have to wonder who really benefits when governments intervene so much in the so called free market.
Do you think this downward trend will continue ? I think the SSE will be around 2,400 – 2,600 points
Yes I do. I think it will drop to the 2,000 to 3,000 range by the end of the year. But that’s just a guess so I’m probably way off, lol.
30% decrease, but it takes 50% increase to get back to the same level. The Chinese government is buying stocks (on top of already owning >1/2 of these companies 🙂 if not the officials are). Anyhow, the last time the US government own stocks (like Citibank, they were making a killing). Just sayin’! 🙂
Investors made out like bandits with Fannie and Freddie as well. I think you might be on to something. We need to find a way to get close to them officials. 🙂
There is a saying: “Robbing in the night time is thief, robbing in the broad day light is … official!” 🙂 I’m not good at translation.
The semi-recent 140% surge of the SSE isn’t all that outrageous when compared to its historical context (instead of comparing it to market performance of different countries…which is a bit absurd). From 1991-1992 the index gained 1,260% — 630%/yr simple average. In 2005-2007 the index gained 500% — 250%/yr simple average.
Even with all the bubbles and busts, SSE’s 25-year average gain is 14%/yr (the S&P is 12%…but no one’s scared of that market. That 2% a year makes a 60% difference in total portfolio size; something to think about before you get all freaked out by “volatility”).
Seems it’s only a “crisis” when over-heated and manipulated foreign markets crash, but it’s a “correction” or “buying opportunity” when local over-heated and manipulated markets crash.
14% a year sounds like a great rate of return. It’s always refreshing to look at the long term trend instead of the last year or so. Kevin O’Leary keeps saying China is still the biggest investment opportunity of our lifetime. Maybe Canadians should use this pull back as an opportunity to start investing in the SSE. 🙂 Any suggestions on a good Asian index fund?
Just my opinion, but I think the easy money* in China is gone; just as the easy money in Western markets is gone (80’s and 90’s). Twenty years ago, my mother of all people, said China was going to be a monster and I should find a way to get on that train. Easier said than done, especially when confronting the wall of Communism. Asian index funds? Not a clue.
*(easy LONG money…I guess you could still make a killing shorting…)
I am, however keeping a sharp eye on the Frontier Markets (e.g. Myanmar, Africa, etc.). Highly risky and not much available at the moment besides a handful of funds, but if one can get in early enough with an actual physical investment…I would say FM could return even more than China. FYI, Coke has already built a factory in Myanmar, one of the few multinationals to do so.
You state, “This leveraging strategy is also recession resistant. For example, let’s say I did the exact same thing in 2007 at the peak of RY’s market capitalization, (the worst possible time to use leverage) right before the greatest recession of our generation. Yikes! Well despite the unfortunate timing, 10 years later I would still end up with a 70% positive return, net of interest expenses!” Also, earlier in your post you state, “I can then apply a leverage multiplier of 5 times…” As you are aware, Royal Bank is normally margin-able at 30%, which suggests 1/0.3 = 3.33 times leverage, not 5 times. How are you able to apply a leverage multiplier of 5 times? Also, why would you want to? Royal Bank hit its intra-day peak on the TSX, for the year 2007, at $61.08, on May 24th. It hit its intra-day low, for the year 2009, at $25.52, on February 24th. Had you had only a leverage multiplier of 2 times (meaning, borrowing a dollar for every dollar invested), with stock marginable at 30%, you would have had a margin call at a loss of 1-(1-0.5)/(1-0.3)=28.57% on the stock. You would have incurred a portfolio loss of… Read more »
Hi Jason. Are you referring to some other post? I didn’t refer to Royal Bank at all in the writing above. I was just trying to get the point across that China’s stock market was overvalued and the correction that happened at the time of the post (2015) could get worse. My prediction of the SSE index leveling off between 2000 to 3000 points seems to be right. Today in 2020 it’s still trading within that range. I remember writing a post about Royal Bank and leveraging a few years ago, but don’t recall the specifics. But I can try to answer your questions. Q: “As you are aware, Royal Bank is normally margin-able at 30%, which suggests 1/0.3 = 3.33 times leverage, not 5 times. How are you able to apply a leverage multiplier of 5 times?” A: There are more ways to leverage into a stock than just using the stock itself as collateral. I have a negative cash balance in my IB account now. Technically speaking any new stock I purchase today in that account will be using 100% borrowed money (infinite times leverage.) But I continue to maintain a wide margin cushion. If I buy 100… Read more »
Hey liquid — deleting my post off of your website doesn’t change the analysis bud. Why not do you readers a service and reconsider instead of doing them a disservice and claiming that with any amount of leverage your RBC purchase in 2007 would somehow have survived through 2009?
Which post was deleted? Sorry. Would you mind elaborating on this please? Sometimes the site’s filter will automatically put comments in the spam folder immediately after the comment is written if it detects something fishy about it, but I have had false positives in the past. If you think this may have happened let me know the day and time you posted and I’ll try to retrieve your comment.