“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. 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 message 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.
They’ve got us this far! As long as we apply them, we will continue to move
forward on the path to your financial goals.
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 if you
have any immediate questions or concerns.
Sources
1 Keith
Bradsher, “Guide to China’s Market Turmoil,” The New York Times, updated
July 9, 2015.
http://www.nytimes.com/interactive/2015/07/06/business/international/china-market-turmoil.html?_r=0
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.
http://www.nytimes.com/2015/06/27/business/international/chinese-stock-indexes-plunge.html
5 Keith
Bradsher, “Chinese Stocks Fall Into a Bear Market,” The New York Times, June
29, 2015.
http://www.nytimes.com/2015/06/30/business/international/chinese-stocks-fall-into-a-bear-market.html
6 David
Barboza, “Stock Sell-Off Is Unabated in China,” The New York Times, July
8, 2015.
http://www.nytimes.com/2015/07/09/business/international/stock-sell-off-unabated-in-china.html
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
Michael L. Schwartz, RFC®, CWS®, CFS, a registered principal
offering securities and advisory services through Independent Financial Group,
LLC., A Registered Broker/Dealer and Registered Investment Advisor, Member FINRA-SIPC. Schwartz Financial and Independent Financial
Group, LLC are separate entities.
