The tepid response of the Shanghai stock market to the Chinese Communist Party (CCP) stimulus efforts has some American market commentators wondering out loud if this is China’s “1929”. Articles on the average investor’s unknown exposure (and destruction of US dollar wealth) to China abound.
The daily charts are nasty, indeed, and on some days the negativity spread to other Asian stock markets.
But comments in the 24-hour business news cycle reflect the industry’s tendency to treat all markets the same and therefore expect all agents in all stock markets to act the same way.
To say this is the start of a Great Depression in China is outlandish and wicked fear mongering. It may attract eyeballs for a few fleeting moments but ultimately it contributes to America’s general misunderstanding of China- something the media should strive to remedy, not perpetuate.
So let’s talk about the disjointed nature of the Chinese stock market, the character of its participants and, yes, what it means for our retirement account.
The first thing to remember about the Chinese stock market is that it is not open to all investors. A previous Contested Spaces blog describes the different types of shares, where they can be bought (and by extension, who can buy them). Americans can buy any Chinese company listed on the New York, Hong Kong, Taiwan or Singaporean stock exchanges, but mostly buy in New York or Hong Kong.
A stock market is used by economists as the poster child of a healthy, liberalized, capitalist economy (assuming away that even the healthiest are highly regulated by their respective governments). Owning a share of common stock is owning a stake in the company- if profitable, the company should pass some of the profits on to its shareholders to reward them for taking the risk to invest. The key here is that an individual has many options in regards to where to keep and grow their money. It derives from a notion in most Western economies to protect private property by respecting the individual’s ownership. During the years under Mao Zedong, the notion of private ownership was so effectively distended that it would be foolish to expect the Chinese stock market, even today, to behave like its American counterpart.
The Rock and Roll Sensation Sweeping the Nation
China’s economic rise has truly been fast and powerful but it has never been free from political control. Special economic zones like Shenzhen flourish under the watchful gaze of the CCP, itself driven by a duty to maintain social stability.
Still, no people are free from crazes. The Dutch had their tulips, we had subprime mortgages and collateralized debt obligations. Every year, a new craze sweeps over the Middle Kingdom, with a network effect many times greater than anything in the US. In just the last few years, there has been a coffee craze and a convenience store craze. As more people saw the profits that could be made, more cafes and 7-11 lookalikes sprung up until the country was hyper-caffeinated and convenienced-out. Those that got in too late lost a lot of money. In 2004, my grateful taste buds benefitted from the craze for Mongolian beef skewers. You could get them at every restaurant and every street vendor, outside the grocery store and at the flower festival. On a visit some years later, nary a beef-skewer was to be found.
The most recent craze has been the stock market and wealth management products (which are only related in that they are both investment options- beyond that they are very different).
In the last five or so years, people have been driven to the so called wealth management shops, which have popped up in old (or new) empty storefronts and apartments, because banks do not offer any savings accounts worth the effort to even think about. Since the 1970s, real estate was the only viable investment option for the average citizen, and naturally, formed a bubble that burst during the 2009 crisis.
Recognizing the need for alternative savings methods, wealth management shops opened their doors, welcoming investors to a steady rate of return based on…
And that’s where it gets scary.
Some wealth management products are based on stakes in mining operations or other similar business ventures. However, most investors don’t know or even care to know where their money is being put to work, only that it generates a good, steady return (wouldn’t we all?).
And then there is the stock market which the government has only recently started to push as a safe and reliable investment option to deter people from the wealth management products. Starved of options and with the promise of a CCP backed positive return, the country got chaogu fever and began speculating in stocks. The pile-on was strengthened by margin accounts, using borrowed money to invest. People switched from placing bets on soccer matches to gambling in the stock market. All of this in less than a year.
Like investors in wealth management products, we cannot say investors in the domestic Chinese stock market are even close to examining the intrinsic worth of companies they are investing in: it has never been done.
The government supposedly took the risk out of investing through stocks. But the premise of a healthy stock market is based on the fear of losing it all, hence the practice of evaluating a company’s profitability. When you take risk out of the equation through political will, the nature of the beast is entirely altered and entirely unsustainable.
Are You Watching Closely?
Thus in June, after the first major fall in the domestic Chinese stock market and the extensive government interventions, I wrote that how the government responds to the next big fall would tell us a lot about how the Party and the people view the stock market. The Party has returned to its silent and shadowy ways and the daily drops have been comparatively minor.
Perhaps these movements will shake out the gamblers, who will go back to their bookies, and become a lesson in the virtues of valuation. Or perhaps people will avoid the stock market altogether and it will continue to reflect the disjointedness between the economy and the stock market.
Because a generation from now, China will still be better off economically. Children will have more opportunities than their parents. We’ll have left explosive growth far behind- but like the recent levels of margin lending, it was always unsustainable.
And all of us exposed to China through our ownership of multi-national companies or emerging market ETFs would do well to remember that we are exposed to China’s economy. If we own Chinese stocks through ETFs, they are companies listed in Hong Kong or New York and are the most analyzed of all Chinese companies.
If we learn anything from what’s going on in the Chinese stock market right now, it’s that relying on assumptions, especially in regards to the actions of another group, is inherently dangerous. Don’t take investments, or grandiose statements, at face value.