Things have certainly changed since I was a child. When I was growing up my father would come outside to give the traditional “dinner whistle.” As was often the case, the common response was “Can we play for five more minutes? Please?”
Times have certainly changed. Today, my “dinner whistle” is often met with:
“Coming, just let me get to save point.”
My kids are huge fans of the Electronic Arts “Battlefield” series of multiplayer military warfare games. The other night, one of the downloadable content (DLC) maps on which they were playing caught my attention. It was entitled “China Rising.”
Had it not been for the recent headlines of the Shanghai index, it would have likely gone unnoticed. However, given the collapse in the index of nearly 30% over the last month, and the potential implications for domestic economy and markets, I thought it was most apropos.
China Rising? Well, it was. And this last week, we saw what the perils of a leveraged market can be when things go “inevitably wrong.”
“The perils of margin debt should not be readily dismissed. For a real time example of financial market leverage and consequences, one needs to look no further than the Shangai Index in China. That market is in a complete collapse as plunging prices are forcing investors to sell shares. While the Chinese government has injected liquidity, suspended trading in almost half of the listed equities and encouraged pension funds to buy securities, these actions have done little to stem the decline as investors “panic sell” in a rush to safety. That collapse, if history is any guide, is likely not done as shown in the chart below.”
“Also, notice the correlation between peaks in the Shanghai Index and the S&P 500. According to a recent Bloomberg article, margin debt in China reached $264 Billion in April of this year. After adjusting for the size of the two markets, is about double that of the roughly $500 billion in margin debt in the U.S.
This difference in relative size was given as a prime example about how margin debt is not a problem for the U.S. However, the relative size of margin debt in the past has not been a “safety net” that investors should rely on. As shown, the level of real (inflation adjusted) margin debt as a percentage of real GDP has reached levels only witnessed at the peaks of the last two financial bubble peaks in the U.S.”
“While no single indicator should be relied upon as a measure to manage a portfolio, it should be well understood by now that leverage is a “double-edged sword.” While rising margin debt levels provide the additional liquidity to drive stock prices higher on the way up, it also cuts deeply as prices fall.”
This weekend’s reading list is a collection of analysis as to the potential impact of the deflating of the Chinese bubble. Will the interventions by the Chinese government stem the tide of selling or only postpone it? More importantly, is history set to repeat itself. “China Rising” may have been the sound of the “sound of the bell” being rung for the bull market that begin in 2009. While it is too early to know for certain, at least things are getting a bit more interesting. Let’s just try and get to a “save point” first.
1) The Greek Crisis Is Nothing Compared To China by Paul La Monica via CNN Money
“Why does this matter to people outside of China? A rapidly sinking stock market is often a sign of an economy in turmoil. Remember 2008? And 2000?
Since China is the second largest trading partner for both Europe and the United States, it goes without saying that a healthy Chinese economy is good news for the developed world. All that talk about the possibility of Greek contagion if it is forced to drop the euro and bring back the drachma? That seems overdone too.
Economists at the Royal Bank of Scotland tweeted out a chart last week that showed that U.S. banks have nearly ten times as much exposure to China than Greece.”
Read Also: Goldman Sachs Says There’s No China Stock Bubble by Cindy Wang via Bloomberg Business
2) Why Beijing Cannot Let Its Bull Market Die by Craig Stephen via MarketWatch
“So this takes us to the current point where controlling the market has been elevated to a test of strength for Beijing and its state-led model.
In China, it shouldn’t be too much of a stretch to believe that the government has the ability to control stock prices through force of will. Beijing has a long history of being able to bend market forces to meet its ends — from interest rates, currency values and the movement of capital in its captive financial system.
But as shares continue to slide regardless of government action, investors are increasingly not buying the government line and, more ominously for President Xi Jinping, they are less willing to believe that he and the party are indeed all-powerful.
To get a sense of what the wider fallout from a correction could be, it helps to compare China now to its previous equity boom-and-bust in 2007.”
Read Also: Why This Chinese Bubble Is Different by John Authers via FT
Read Also: 5 Reasons Why China Really Matters by Mohammed El-Erian via Bloomberg
3) China’s Big Misquided Gamble On Its Stock Market by Minxin Pei via Fortune
“In real market economies, stock crashes of such magnitude may cause heartburn but unlikely precipitate frenzied government efforts to prop up equity prices. But China is, as we know, not exactly a market economy and has a government that acts differently. In response to the latest crash, instead of allowing market forces to self-correct, Beijing is rolling out aggressive measures to keep the bubble from popping completely.
Beijing should be building social safety nets and recapitalizing its banks, not betting the house on a stock market bubble.”
Read Also: China And The Delusion Of Control by David Keohane via FT
4) China Or Grexit? What’s Driving Markets by Bryce Coward via GaveKal Capital
“While some of the post Greferendum moves in financial markets could have been and were predicted by the financial punditry – lower euro, lower stocks, lower US bond yields, higher gold – the real moves have appeared elsewhere. Indeed, as of this writing the euro is only lower against the USD by less than .5%, the MSCI World Index is barely off by 1%, bonds are bid, but not emphatically, and gold is only marginally higher.
The real moves have been in oil (WTI down 6.3% and Brent down 5%) and copper (down 3.9%). While at first glance this may strike one as odd, there could be something larger at work. Perhaps the more important catalyst for asset price changes of late is Chinese economic slowing rather than fears of Grexit?“
Read Also: US Stocks: Last Man Standing by Meb Faber via Faber Research
5) China’s Stock Market Crash Is Just Beginning by Howard Gold via MarketWatch
“As I’ve written many times, China, Brazil, Russia and other emerging markets are suffering through secular bear markets that will last years. Since Chinese stocks represent more than 20% of some emerging-markets ETFs, the pain will likely continue well into this decade.
Secular bear markets feature sudden, violent rallies and mini–bull markets that fool people into thinking they’re the genuine article. In real bull markets, indexes repeatedly top their previous highs; in bear markets, they never do.”
Read Also: Chinese Stocks: What’s Behind The Great Market Tumble? by Knowledge@Wharton
Other Interesting Reads
Why Momentum Investing Works by Ben Carlson via Wealth Of Common Sense
Cyclical Bull, Structural Bear Still by Eric Bush via GaveKal Capital
Old Economic Thinking Is The Problem, Says BIS by Ynes Smith via Naked Capitalism
“难得糊涂(nan dé hú tu) – Where ignorance is bliss, it’s folly to be wise.“ – old Chinese proverb.
Have a great weekend.
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