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    Oh CHINA!

    By

    July 28, 2015

    “Red Red everywhere not a shade of Green”

    July 27, 2015, will surely be an unforgettable day for the Chinese. After all, yesterday Shanghai Composite witnessed its single biggest fall since the turbulent times of the sub-prime crisis in 2007-08.

    The Shanghai Composite Index shed 8.5 percent to close at 3,725.56, with 75 stocks dropping for each one that rose.

    The recent happenings in world’s second largest economy have sent shockwaves throughout the world. And, the sheer magnitude and overwhelming phenomenon go on to emphasize the fragility of the global economic system.

    China stocks slump 8.5% as Shanghai Composite saw the biggest loss since 2007

    But the loss yesterday is not an ad hoc effect or some market abnormality. The Chinese markets have been in news for quite some time now, and not for the right reasons, at the least.

    So What Has Transpired ?

    The Chinese markets had grown more than a 150% in a time-frame of less than 15 months – till June 2015. The same markets have crashed by almost 40% since mid-June.

    It’s not just the boom and ongoing bust which is worth reflecting upon, but the causes and consequences of such movements have taken us aback.

    “In last few weeks, the market capitalisation of Chinese capital markets has eroded

    by $3.5Tn, equivalent to 1.5 times the size of the Indian economy”

    Normally, the capital markets are an indicative of the health of an economy. They reflect the sentiment about an economy as a whole accompanied by investor expectations. Thus, the stocks go up during booms and fall in the rainy season. But the exponential rise in China that began in mid-2014 didn’t reflect a growing Chinese economy, rather it was marred by sluggish real estate, overcapacity and creeping deflation.

    What is scarier is the fact that ordinary investors buoyed by the rising markets, started to enter, putting in their savings along borrowed money in the hope of reaping quick gains.

    But as the Mr. Buffett says

    “The investor of today does not profit from yesterday’s growth.” And so again, the irrationality took over the rational side of human mind.

    Consider the following quick points reflecting the craze –

    1. More than 10 million new stock accounts have opened so far this year, more than the total number for all of 2012 and 2013 combined
    2. The herd mentality had taken over, with most speculators entering at the peaks
    3. About two-thirds of new equity investors left school before the age of 15. That shall be enough to conclude the stock markets were treated as a gold mine rather than an investment vehicle
    4. The Price- Earning multiples of Chinese technology stocks are hovering at twice the levels of the American stocks at heights of the dot-com bubble in 2000
    5. From the next door health club Co. to any other mom and pop store, every second Co. had achieved a PE multiple of 70

    A recipe for disaster was ready. And the service has just begun.

    Bears have tightly gripped the market.

    The kiss of death is yet to come.

    The Consequence

    The practice of margin trading, which was eased to promote stock market investment has done too badly for the country. Selling compulsions on account of margin calls have further drove down the markets.

    Though the Chinese Government interfered in the financial system by reducing the interest rates, punishing short selling, and announcing to ear mark $500Bn to absorb the sell side pressure, today’s market movement indicate the markets are refusing to relent.

    Bottom line is China has lost the plot, again.

    1. The small investor/ speculator has lost his shirt
    2. And the nation has lost its reputation because of an unsustainable financial system and perpetual rigging by Government of a financial system – which is supposed to present an unbiased view of the economy. Its dreams of making Yuan a globally acceptable currency have shattered.

    Conclusion –

    The episode had attributes of another great stock market disaster. Unjustified sky high valuations, weak fundamentals and to top it all a communist Government, the Chinese bubble was bound to pop at some time.

    The paradox is the fact, this cycle would repeat. In 2008 it was the USA taking down with it the entire world, this time it is China, next time it may happen in our own backyard.

     

    Views presented in the article are those of the author and not of ED.

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