Remain calm
We need to remain calm while the market tries to figure out what to make of China. In my opinion, people should not be selling. And, people should not be changing their prior convictions because of what is currently occurring. This means that if you believed that being in a large cap portfolio was the best investment option last week, then I don’t see why you should think differently this week. Because eventually, the market will figure out that things are actually pretty okay in China. So, the markets will rebound, and they will rebound quickly.
Here is why.
China is fine
First, the current concern over China is unwarranted. Last year, at around this time, the Shanghai Composite Index was at around 2,200, and then it went up to over 5,000. Now it’s down to around 3,000, so the Chinese markets are still way up for the past year. Their stock market exhibited irrational exuberance, driven partially by huge optimism because China was going to start allowing IPOs for the first time in recent years. Yep, that’s right. For several years, there were no IPOs in China. This is because they were overhauling their IPO process from an approval system to a registration system, akin to the U.S. registration system. When China announced that they would soon be allowing IPOs to go forward, there was a lot of exuberance in the Chinese stock markets. But market participants were excessively exuberant. And the stock market bubbled. With any bubble, it will eventually pop, and it did.
This is all that is happening with China’s recent crash.
Also, what’s actually kind of funny about all of this is that China’s stock markets aren’t even that important to begin with, and so the current fixation over its declining value is misplaced. People in China generally don’t rely on stock investing for their retirement. And, Chinese firms do not generally raise capital via stock. So, it’s strange the world outside of China is so fixated on what’s been happening with the Chinese stock markets in recent days.
This is more like 1987 than 2008
I don’t see any fundamental flaws in China’s real economy. When the U.S. market crashed in 2008, it was because there really was a problem with the real economy. Back in the mid-2000s, people who should not have qualified for mortgages were getting them, and then they subsequently started defaulting on them. This caused the mortgage-backed securities markets to collapse. And giant financial institutions that were overexposed to those securities soon tumbled. And, as we all know, they dragged the global economy down with them. It took several years for us to climb out of that crash. For example, look at Figure 1. It’s the S&P500 index value during a 2-year period immediately before and after the September 29, 2008 crash. You can see that the market even continued crashing after it! And during this 2-year window, the market doesn’t fully recover.
Figure 1:S&P500 around the 2008 crash Yahoo Finance - Period beginning 08/01/2008, ending 08/01/2010
(last visited August 25, 2015)
Figure 2: S&P500 around the 1987 crash Yahoo Finance - Period beginning 09/01/1987, ending 09/01/1989
(last visited August 25, 2015)
But why does the Chinese market continue to fall?
But in the meantime, everyone is concerned that the Chinese markets keep falling. This is simply happening by design! And I am surprised that the media is not aware of this. China’s stock markets use a 10% daily price limit on stocks. So, if the Chinese markets are overvalued by 30%, then a correction in China cannot occur within a single day. So, when the Chinese markets are down on consecutive days, it’s economically meaningless.
More reasons to believe that China is, and will be, fine
Finally, as a finance professor in China, as a researcher of Chinese financial markets, and as a frequent economic commentator on China’s only English-speaking national news station, I had to keep up with Chinese economic policy. In my opinion, China does many things right: they are careful about their growth, and their monetary and fiscal policies are sound and conservative. Some people are pointing to the slowing manufacturing sector in China, but that is intentional. China does not want growth for the sake of growth. And at the end of the day, their economy will continue to grow.
Finally, what is the effect of China devaluing its currency? This is good for China’s exporting, because it makes their goods cheaper to the rest of the world. But of course, a cheaper Chinese currency is not good for other exporting countries that compete with China. But in my opinion, what’s best for China is really best for the global economy. Let’s not forget that China’s economy is what eventually brought us out of the 2008 recession.
In short
It is my belief that the markets will soon realize that everything that I have said above is the reality, and my prediction is that the markets will bounce back from this current crash quicker than it did in 2008.
In short, China’s economy is fine. And, we are not in the midst of another 2008; instead, it feels more like 1987.
Kenneth A. Kim, PhD, cited as one of top 15 economists in China*, is EQIS's Chief Financial Strategist. Dr. Kim also worked as a Senior Financial Economist at the U.S. Securities & Exchange Commission in Washington DC, and has also worked for the CFA Institute, the Securities Litigation Consulting Group, the Kuala Lumpur Stock Exchange, and the University of Wisconsin Credit Union. Dr. Kim was a tenured finance professor at the State University of New York at Buffalo. Dr. Kim has been quoted or his research has been cited in the Wall Street Journal, Barrons, Forbes, Financial Times, BusinessWeek, NewsWeek, New York Times, Washington Post, Boston Globe, TheStreet.com, Kiplingers.com, Fidelity.com, CNBC, Channel News Asia, and China Central TV.
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Disclosures:
The information contained herein is developed from sources believed to be reliable and is provided for informational purposes only. The information is provided for comparative purposes only to reflect the opinion of the author and is not intended to be, nor should it be construed as providing investment advice. Advisory services are offered through Eqis Capital Management, Inc. (“EQIS”) a registered investment adviser. This is not an offer to sell securities or provide investment advice which may be done only after a client suitability review is conducted and appropriate disclosures made.
The S&P 500 comprises the 500 largest publicly traded companies in the U.S. and is often used for comparative and/or illustrative purposes. Indexes are unmanaged and one cannot invest directly in the index. Any investment will typically incur additional expenses such as management fees and trade costs which will not be reflected in an index. Past performance does not guarantee future results. All investments carry with it a degree of risks to include the potential for a total loss of principal. Investing in foreign securities or emerging markets carry with it additional risks such as political uncertainty and currency exchange risks among others.
