Last Week Greece – Now China

“Nothing in life is to be feared. It is only to be understood.”

-Marie Curie

Many people have asked me about the recent news out of China. “What’s happening to their stock market?” they want to know. “Will it affect us? Should I be worried?”

I offer the above quote as a response. Nothing in life is to be feared, it is only to be understood … and that includes what’s happening in China. We sent a brief overview in our weekly newsletter, so let’s take a few minutes to understand it!

The Year of the Bull Turns into the Year of the Bear

For about a year, China’s stock market has been on an incredible hot streak. In fact, it’s more than doubled in value over the past twelve months.1 That’s because millions of people—mostly working class families who previously had little to do with the markets—have been pouring their money into stocks.
This trend was driven largely by government-created hype. For months, state-owned media has been urging people to buy stocks, loudly proclaiming that the markets were the place to put their money.2

The resulting growth was explosive … and ultimately, unsustainable.

As the demand for stocks increased, so too did stock prices. But that didn’t deter investors, who kept buying as long as stocks looked like they were going up. They even engaged in some very risky behavior in order to keep buying. Many people even borrowed money to invest, a practice known as margin trading. Think of it like taking out a loan just so you can hit up a casino. All investing comes with risk, of course, but margin-trading takes the concept to an entirely different level. It’s an easy way to turn “investing” into “betting.”

To make a long story short, stock prices rose too high, too fast. Meanwhile, the overall Chinese economy has actually been slowing down, and, despite its size, is thought by some analysts to be relatively weak in terms of growth.3 Financial experts have a name for when stock prices skyrocket above the value of the actual companies behind them.

A bubble.

Starting in June, the bubble finally began to pop. Ready for some numbers? On June 26th, the Shanghai and Shenzhen composites, the country’s two biggest indexes, both fell over 7% in one day.4 By the end of the month, stock prices had declined more than 20 percent from their June 12th peak.5 By July 9th, the two indexes had both fallen over 30%.6 Investors had finally woken to the fact that their nation’s economy wasn’t an effective prop for their nation’s markets … and that their own over-borrowing was a problem. Once again, investors acted emotionally—but this time, out of fear instead of greed. Their sudden loss in confidence led to a sharp drop in the stock market.

The Chinese Government Responds

Of course, China’s communist leaders weren’t about to just sit back and do nothing. Instead, they’ve enacted a slew of policy changes to try and stop the financial bleeding. For instance, they have:

  • Ordered brokerages to continue buying stocks in an attempt to prop the markets up
  • Lent money to said brokerages for the same purpose
  • Announced new regulations on margin-trading and short-selling
  • Cut interest rates to record lows
  • Banned trading shares in companies whose stock is falling too fast

And that’s only the tip of the iceberg. Whether these measures are wise is an open question, but the point is, the government is working overtime to reassure the masses. As of Friday, July 10th, there are signs their efforts may be working. Both indexes closed the day up 4%.7 Time will tell whether things have truly stabilized.

What Happens Next?

Assuming the worst is over; China will need to turn its attention to the overall economy. If it continues to weaken, then the markets could resume their plunge. How does that affect us? Well, you may have heard the saying that “When a butterfly flaps its wings in China, a tornado forms in Kansas,” or something similar. That’s an exaggeration, of course, but in this interconnected world of ours, what happens on one continent can affect another. After all, China’s economy is the second largest in the world. Their slump could, in theory, spread to other markets as well. The good news is that despite the recent slide, China’s markets are still up over 70 percent from where they were a year ago.6 The real question is, “What can we learn from all this?” Remember Marie Curie’s words: nothing should be feared, only understood. That’s why, instead of worrying about China’s immediate future, it makes more sense to see what we can glean from China’s recent past.

Lessons Learned

“Learning is a treasure that will follow its owner everywhere.”

– Chinese proverb

All this drama serves as a useful reminder of why the basics of investing are so important. For example:

  • Never invest emotionally. Proper investing comes from having a sound strategy, preferably one that exists within an overall financial plan. The two Rs, ration and rules, are an investor’s best tools. Unfortunately, too many Chinese investors did the opposite. They invested emotionally. When stocks went up, exuberance prevailed. When stocks started going down, fear took over. Both ended up being harmful.
  • Don’t rely on the media. Whether it’s state-owned or private, the media has a vested interest in stirring up emotions. In China’s case, people believed the media’s hype instead of relying on critical thinking or common sense. Never make financial decisions based solely on what you read in the newspaper.
  • Don’t try to invest what you don’t have. Excessive margin-trading is having a destructive effect on many Chinese families. Investing is not gambling … or at least, it shouldn’t be. Regardless of how well off we are, we all have to live within our means.

I hope this article makes the China situation a little more comprehensible. In the end, my professional advice is this: always try to understand the “what” and “why” of what you hear in the news. But don’t waste time fearing the “what if.” Remember the basics of sound investing.

Finally, always know that my team and I are here for you. We will continue to watch the markets, both in China and elsewhere. We will never stop educating ourselves about what’s happening in the world. And if there are any further developments we feel you should know about, rest assured you’ll hear from us promptly.

In the meantime, have a great summer! Please contact me at 217-337-5584 if you have any immediate questions or concerns. Or you can sign up for our newsletter below to get updates on current events and how they are affecting the market.

Securities and Advisory Services offered through Triad Advisors Member FINRA/SIPC

Sources
1 Keith Bradsher, “Guide to China’s Market Turmoil,” The New York Times, updated July 9, 2015.

2 Charles Riley & Agnes Chan, “How China’s media and risky trading fueled stock market crash,” CNN Money, July 8, 2015.
http://money.cnn.com/2015/07/07/investing/china-stock-market-crash/index.html?iid=surge-stack-dom
3 “Why China’s economy is slowing,” The Economist, March 11, 2015. http://www.economist.com/blogs/economistexplains/
2015/03/economist-explains-8
4 David Barboza, “China’s Stock Market Plunges,” The New York Times, June 26, 2015.

5 Keith Bradsher, “Chinese Stocks Fall Into a Bear Market,” The New York Times, June 29, 2015.

6 David Barboza, “Stock Sell-Off Is Unabated in China,” The New York Times, July 8, 2015.

7 Charles Riley, “China stocks rebound,” CNN Money, July 10, 2015. http://money.cnn.com/2015/07/09/investing/china-stocksshanghai/
index.html?iid=hp-stack-dom

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