Business

China: speed, scale, and sheer irrationality of stock market bubble is unprecedented

July 7, 2015
Hong Kong

[Editor’s Note: This missive was penned by Tim Staermose, Sovereign Man’s Chief Investment Strategist.]

The Chinese stock market bubble is bursting. And the government is hitting the panic button.

Having actively encouraged the bubble with cheap money, lax margin loan regulations, and constant cheerleading and propaganda, Chinese authorties apparently also think they can mop up the mess.

Wrong.

Time and time again, governments who get into the game of managing the level of stock market indices always fail.

It happened in Taiwan in 1994, and South Korea in 1997. Both were unmitigated disasters.

The consequences will be wide-reaching; China’s is the biggest stock market bubble ever.

In 1928-1929, prior to the great crash that ushered in the Great Depression, the Dow rose 100% in 18 months. China’s markets were up 150% in just 8 months.

In 1999, just prior to the epic NASDAQ tech bubble bursting, the average NASDAQ stock traded on a multiple of 59 times earnings.

In China, the Shenzhen index just topped out with an average price to earnings (P/E) ratio of 116 times.

The speed, scale, and sheer irrationality of China’s latest stock market bubble is unprecedented.

The Financial Times, among others, has reported that two-thirds Chinese retail stock market clients who have opened new accounts this year did not even graduate from high-school.

Surveys indicate one quarter of new investors have already lost at least 50% of their money.

Nearly half a trillion dollars (about one third of China’s annual econmic output) has been wiped off the value of Chinese stocks in the past two weeks.

And it’s probably going to get worse.

Nothing goes up or down in a straight line; so while there may be a brief rally, Chinese stocks are set to continue tanking.

The economy is slowing. The banking system is infested with bad loans. Money will continue to flee the country. And the currency will be forced to devalue.

Greece is a sideshow. China is the real worry right now.

But, if you are wired the way I am, a period of exceptional financial volatility is something to get excited about.

It’s highly unlikely that a major crash in the second largest economy in the world won’t have a knock-on effect around the globe– especially as many western markets themselves are in their own bubble territory.

Opportunites to buy shares in good companies that will withstand the turmoil at cheap prices are to be welcomed. Don’t fear the volatility. Use it to your advantage.

China