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The Chinese stock
markets have been rocketing higher in a popular speculative mania.
New Chinese investors are flocking to their local red-hot markets,
borrowing heavily to buy hyper-speculative stocks. Like all past
manias, this one is guaranteed to end badly. And when China?s
parabolic stock indexes inevitably collapse, the global stock
markets face serious risks of getting sucked into that fear-fueled
stampede.
The Chinese people
are endlessly fascinating. After being blessed to travel to China
several decades ago as a kid, my interest in that country and
culture has only grown since. One thing the Chinese are renowned
for is their intense competitiveness. Their work ethic is
legendary, as they zealously strive to improve their lots in life.
So wealth, and the perception of it, is exceedingly important
socially in China.
The stories of
this phenomenon are endless. A recent example happened in spring
2013 after what was essentially
a gold panic.
Right after gold?s plummet, Chinese housewives rushed to buy
up gold to the tune of $16b in a couple weeks! Why? Most
interviewed by the media said something along the lines of they
didn?t want to be upstaged on the gold-jewelry front by their
friends who were splurging on gold too!
The Chinese people
are constantly comparing their own wealth with their perceptions of
how their peers are doing. They can?t stand the thought of being
left behind, as they will lose critical social status. Add this to
the overpowering Chinese desire for upward social mobility, and this
people?s centuries-old deep cultural affinity for trading, and there
is probably no more-perfect breeding ground for a stock mania to
ignite.
And over the past
half-year or so, one has. The Shanghai Stock Exchange is China?s
premier stock-trading venue, and its namesake Shanghai Stock
Exchange Composite Index (SSEC) is that country?s flagship
stock-market benchmark. It is China?s equivalent of the US?s
flagship S&P 500, and is even constructed similarly. It includes
China?s biggest and best companies, representing that country?s
economy.
And with over 850
component companies, the Shanghai Comp is an even-superior
broad-market metric than the S&P 500. So as you marvel at the sheer
magnitude of this Chinese stock mania in this SSEC chart, imagine
how risky American stock markets would be if the S&P 500 did this.
I?ve been watching this Chinese mania accelerate for months,
devouring reports on it, yet seeing this chart is still shocking.
China?s flagship
broad-market stock index, never mind its far-more-speculative
Shenzhen-stock-index cousin, has literally blasted vertical
this year. In has skyrocketed 79.5% higher in just the past 5.1
months! Extend that to 5.8m, and the Shanghai Comp is up an
astounding 92.0%. And over the past 9.4 months, not much time in
the grand scheme of market cycles, the SSEC has catapulted 115.8%
higher!
So essentially the
Chinese stock markets have nearly doubled over just the past
half-year or so. Such gains would be extreme in any market in
any era, but are even more incredible in a broad-market stock index
representing a great nation?s best businesses. The Chinese people
are flooding into local stocks with reckless abandon, racing to
throw every yuan they can get their hands on at these soaring
markets.
This extreme stock
mania only ignited back in late November. In the first half of
2014, normal market conditions existed as the SSEC drifted 3.2%
lower to properly reflect a slowing Chinese economy. The stock
buying started typically as well, in late July 2014. A survey of
corporate purchasing managers, a PMI report, came in at an 18-month
high implying the weak Chinese economy was finally starting to
recover.
By early October,
a combination of better Chinese economic data, rallying world stock
markets, and the surging US dollar which would make critical Chinese
exports cheaper for American customers worked to fuel a 17.2% SSEC
rally. These were strong gains in just 3 months, but certainly
nothing abnormal. It continued into mid-November, running up to a
22.4% gain in 4.1 months. That was starting to look excessive.
So Chinese
investors wisely started to realize profits, and their bearishness
and pessimism mounted rapidly. Stock-market levels have a
pronounced wealth effect on any country?s overall economy.
The higher stock prices climb, the more optimistic businesses get
and the looser their purses in spending on investment and hiring.
Beijing was worried a stock-market selloff would exacerbate
spreading economic weakness.
So on Friday
November 21st, the People?s Bank of China made a surprise move. In
what was seen by the rest of the world as a sign of near-panic, this
central bank slashed its main interest rate by 40 basis points to
5.6%. This was the PBoC?s first rate cut since way back in July
2012, and was a direct attempt to combat China?s slowing economy.
That central-bank-easing surprise ignited the subsequent
stock mania.
The world?s stock
traders are high on the notion that central-bank money printing can
magically manage stock-market levels, leading to endless rallies
without material selloffs to rebalance sentiment. History has
proven this false in spades, showing that excessive money-supply
inflation always leads to bubbles and subsequent busts. But
thanks to the extraordinarily anomalous US stock-market rally,
traders have forgotten.
Since early 2013,
the US stock markets have powered relentlessly higher without
normal selloffs due to the Fed?s radically-unprecedented third
quantitative-easing campaign. The Fed conjured up $1590b out of
thin air to buy bonds, forcing interest rates to artificial lows.
This led US corporations to borrow vast amounts of money to buy back
their stocks, around a half-trillion dollars in 2014 alone.
So the US stock
markets levitated.
Stock traders
around the world are convinced QE3 was a huge success, even though
the fat lady hasn?t sung until US interest rates are normalized and
the Fed?s massive bloated balance sheet is shrunk back down to
pre-QE levels. So they have come to believe that central-bank
money printing is always good for stock markets globally. Now
whenever a central bank eases, they rush to buy stocks in its wake.
So with the
People?s Bank of China following in the easing footsteps of the Fed
and Bank of Japan, investors rushed to pour capital into Chinese
stocks following that surprise rate cut. In just over 2 weeks after
that move, the Shanghai Comp had surged another 23.2% higher
by early December! Its total rally was up to 48.2% in just 5.0
months, with over 4/7ths of those gains driven by the PBoC?s
near-panic easing.
Now if you were
trading during the US stock-market mania in early 2000, you
certainly remember all the breathless news coverage. The
mainstream media endlessly reported on the red-hot stock
markets, and stories abounded of ordinary investors multiplying
their wealth in a matter of months. This same thing just happened
in China, really playing into that universal Chinese pastime of
wealth comparison and social aspirations.
Chinese people
hated the idea that their peers were getting rich in the soaring
stock markets while they were not. And with Chinese real estate
slumping, and gold in yuan terms dropping 18.0% between March and
November 2014, there were few enticing investment alternatives. So
the Chinese started to plow capital into the stock markets to chase
the SSEC?s incredible gains, led by legions of new investors.
As veteran
hardened investors and speculators know, buying low and selling high
is not an easy game. Our human emotions of greed and fear
constantly betray us, making us overwhelmingly feel like
buying high and selling low when the rest of the herd is. The best
way to combat these dangerous emotions is with knowledge. The more
you know about market history, the less likely you?ll succumb to
popular sentiment.
The new Chinese
investors plunging into the stock markets were far-less-educated
than the existing ones. Bloomberg reported on some research in late
March showing that a staggering 2/3rds of new Chinese
investors in recent months had a junior-high-level education or
less. A quarter only completed some elementary school, while 1/17th
were actually considered ?not literate? with no formal education at
all!
Now there are
likely ultra-rare edge cases where some whiz kid raised on the
streets forges himself into an elite trader, running circles around
others with doctorates. But in general, the lower someone?s
education level the greater the odds they won?t really understand
what drives stock markets and how risky they are at any given point
in time. It?s not pejorative, but ?dumb money? truly fueled this
Chinese stock mania.
And it gets even
worse. Just like in the US stock mania back in early 2000, many if
not most of these new investors opened margin accounts. They
didn?t only throw their own capital into soaring stocks, but rushed
to borrow more money to multiply their holdings. By mid-April,
Chinese stock traders had already borrowed the equivalent of a
record $194b to buy stocks! That is crazy-high relative to the size
of those stock markets.
Just like in the
States, Chinese stock investors are legally limited to 2-to-1 margin
through their brokerages. They can only double the money they have
deployed in stocks. But also like in the US mania back in early
2000, Chinese investors have been circumventing these limits with
personal debt. They are borrowing on everything they can, and
eagerly casting that money too at their red-hot stock markets!
The net result of
this frenzy of uneducated new investors borrowing to buy stocks is
striking in this chart. The light-red curved line above is directly
traced (and then slightly offset) from the Shanghai Comp?s price
action since last summer. And it is a perfect parabola, the
most dangerous price pattern in all the markets at a large scale
during a popular speculative mania. There is no doubt this thing is
going to collapse.
For many weeks the
skyrocketing SSEC has been exceeding its upper Bollinger Band. This
is a key technical construct 2.5 standard deviations away from the
base stock-index level. Seeing any price 2.5 standard deviations
above its 50-day moving average is rare, as that encompasses just
0.6% of the entire probability band. And the Shanghai Comp has been
beyond 2.5 standard deviations above for
weeks on end!
In addition, as of
this essay?s Wednesday data cutoff the SSEC was stretched an
astounding 57.1% above its 200-day moving average! To see a major
stock index push just 10% above signals serious overboughtness, and
20% over is extreme. The higher this gap between an index and its
200dma balloons, the greater the probabilities a big and sharp
selloff is imminent to restore balance to euphoric markets.
So this Chinese
stock mania really looks like it is on the verge of a total
collapse. And provocatively it almost happened last weekend!
Three hours after the Chinese stock markets closed for the weekend
on Friday April 17th, a report emerged of an official crackdown on
the excessive Chinese stock speculation. Chinese regulators were
apparently discussing restricting margin trading for
over-the-counter stocks.
Sharply reducing
margin debt is the quickest way to kill a stock mania, forcing
traders to stop borrowing to buy more stocks. And depending on how
it is implemented, it may even require traders to sell down their
existing leveraged holdings to repay those debts. On top of that,
Chinese regulators said they were going to start allowing
institutional investors to short sell Chinese stocks, another
downside influence on prices.
While the Chinese
stock markets were closed for the weekend, the reaction in the
futures markets was swift and brutal. SSEC index futures were soon
plummeting nearly 6%! And since Chinese investors had all
weekend to stew over this and worry, Monday morning was shaping up
to be a total bloodbath. It would not have surprised me one bit to
see the Shanghai Comp crash on the order of 10% that day.
The Chinese
government was well aware of these risks too, so I imagine many
tense weekend meetings on how to deal with this furious stock
selloff. Once parabolic stock markets break, the selling cascades
for a long time. And if the millions of new leveraged Chinese stock
investors were wiped out, there were serious risks of sharply
reduced spending from the negative wealth effect and even widespread
civil unrest.
So on Sunday, the
People?s Bank of China swung back into action to arrest the popping
of the bubble that it itself had spawned back in late
November. It slashed Chinese banks? reserve-requirement ratio by
100 basis points to 18.5%. This reeked of panic too. Not only was
it a surprise, but it was the biggest triple-R cut since December
2008 in the dark heart of that global stock panic! The Chinese
government was scared.
And that
last-ditch gambit to prevent the parabolic Chinese stocks from
cratering paid off. Monday?s loss on close in the SSEC was a mere
1.6%, trivial compared to what was likely to transpire before
China?s central bank rushed to the rescue. But all stock manias
inevitably end in a symmetrical collapse, their demise can
only be delayed for so long by any means. So China?s ugly day of
reckoning is still coming.
Smart Chinese
investors who study market history should know exactly what to
expect. This next chart extends the SSEC back to 2007, which
encompasses the Chinese stock markets? last popular mania that
year. And just like today?s is certain to do, the last one ended
badly. The parabolic stock markets didn?t just correct, they
utterly collapsed. That?s the common outcome after all popular
stock manias in history.
The extremeness of
today?s parabolic Chinese stock markets is even more striking in
this long-term chart. They rocketed from normal to vertical right
after that late-November surprise PBoC rate cut. The SSEC just hit
a 7.1-year high in the middle of this week, the best levels since
the last parabola. And that one was a disaster. After skyrocketing
96.7% higher in 2007, the Shanghai Comp collapsed 65.4% in 2008.
And that?s on a
calendar-year basis, the absolute magnitude of the stock mania and
subsequent plunge in China?s flagship broad-market stock index was
even more extreme. Between February and October 2007, the SSEC
skyrocketed 133.2% higher in 8.3 months. Today?s parabolic gains of
115.8% in 9.4 months are certainly comparable. Over the next year
or so into November 2008, the SSEC collapsed 72.0%!
Now that last
post-parabola bottom in the SSEC happened during a rare global stock
panic, so I doubt we?ll see similar extremes after this current
stock mania bursts. But declines on the order of 50%+ are still all
but certain. With Chinese investors? overwhelming wealth
consciousness, imagine how miserable the mood in that country will
be when these stock markets mean revert far lower to normal levels
again.
Ominously, that
last mania peaked with the Shanghai Comp stretched 58.0% above its
200dma. That is nearly identical to this week?s 57.1%! The Chinese
stock markets are about as extremely overbought as they can get.
Also provocatively, the last Chinese parabola topped in October
2007 just as the last American cyclical stock bull was topping
as well. That heralded a brutal 56.8% cyclical bear in the S&P 500!
With all the
world?s stock markets now extremely overextended and overvalued on
central-bank-conjured euphoria, there?s a high chance the bursting
of China?s stock-market bubble will suck in the rest of the world?s
lofty stock markets as well. A major reversal in the fortunes of
China?s red-hot stock markets is one of the leading potential
catalysts to spark the long-overdue major selloff in the US stock
markets.
So American
traders have to closely follow the Shanghai Composite and
developments in China. There are ways for Americans to directly
game the Chinese stock markets as well, with a couple dozen or so
ETFs that track various Chinese stocks. The leaders are the iShares
China Large-Cap ETF (FXI) and Deutsche X-trackers Harvest CSI 300
China A-Shares ETF (ASHR). Both should be shorted or putted.
There?s a derivate
play too, in gold. Chinese investors have forever had a deep
cultural affinity for the yellow metal, which has been temporarily
forgotten in this seductive stock mania. When Chinese stock markets
roll over and losses start mounting, Chinese investors are going to
scramble for diversifying exposure into gold. We could see massive
gold buying, driving it and its leading ETFs like GLD much higher.
With the aftermath
of the Chinese stock mania very likely to drag down lofty world
stock markets, it is very important to cultivate a studied
contrarian perspective these days. That?s our entire mission at
Zeal. We?ve spent decades intensely studying and trading stocks,
which has forged exceptional experience, knowledge, and wisdom. We
apply that to current markets to explain what?s going on, why, and
how to trade them with specific stocks. You can harness this
valuable analysis for yourself in our acclaimed
weekly and
monthly
newsletters.
Subscribe today before China rolls over!
The bottom line is
China?s stock markets have skyrocketed in a classic popular
speculative mania. Millions of new Chinese investors with little
education are rushing to pour all the cash they can get their hands
on into parabolic stocks. And they are doubling down on these risky
herd-mentality bets with extensive borrowing. This is absolutely
going to end badly, in a total collapse as all speculative manias
do.
And the resulting
pain is likely to spread far beyond China, as all the world?s major
equity markets are at or near major highs thanks to extreme
central-bank money printing. At some point, traders? faith in these
market-manipulating institutions to nullify normal stock-market
cycles will wane then vanish. And once that happens, the mean
reversions down are going to be massive. It could all start with
China?s stock bubble popping.
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