Stumble, Recovery ... Fall?


This is an excerpt from Cabot China & Emerging Markets Report, which seeks to capitalize on the big boom in China and other emerging market countries. Editor Paul Goodwin, Cabot’s international investing guru, provides your passport to profits.

Sometimes during a foot-race, you’ll see a runner stumble, then seem to get his footing back. Then, after a few paces the runner loses it completely and falls in a heap.

While we don’t have a crystal ball, it’s possible that the situation in the Chinese stock market is following just such a pattern.

The Shanghai Composite Index is the Chinese equivalent of the Wilshire 5000 Index, a capitalization-based measure of all the stocks that trade on the exchange.

The Shanghai Composite topped out on June 12 at 5,166, capping a four-month run from 3,095. By July 3, the Shanghai Composite had retreated to 3687, a 29% decline. That’s the stumble we were talking about.

At that point, the Chinese government pulled out its entire arsenal of market supporting tools and pulled the trigger. Trading fees, margin requirements and borrowing rules were lowered, buying of stocks by government entities ramped up on a massive scale, the shorting of stocks was prohibited (and some short traders were arrested) and at least half the stocks on the Shanghai Exchange were withdrawn from trading.

The Shanghai Composite responded well to this program of support, popping to 4,124 on July 23. That’s the recovery.

But despite the program of support, the Composite was back below 3,600 (intraday) on July 29. And while the outcome of this clash of titans (The Government vs. Individual Investors) is still in doubt, it looks like the fall-in-a-heap phase may have kicked in.

We’ve already looked at the reasons for the souring of Chinese investors’ love for the market, but it’s safe to say that a major reason was the large number of inexperienced, uninformed investors who joined the rally late in its advance. By one estimate, there were 170,000 new stock trading accounts being opened every day in May and June on the Shanghai Exchange, which was more than 10 times the average for 2014. Euphoria was the order of the day.

And those enthusiastic late arrivers are the ones who really got murdered during the big correction. They won’t forget that disappearance of wealth anytime soon. If you think hell hath no fury like a woman scorned, you haven’t seen a naïve investor who came late to the party and lost his shirt.

The Cabot China & Emerging Markets Report’s portfolio has weathered this storm pretty well. We moved quickly to a heavier cash position by jettisoning our weakest performers and increased our exposure to non-Chinese stocks.

But China is still the Big Dog of the emerging markets, and we are watching closely to see which tendency comes out on top, the Recovery or the Collapse.

A researcher and writer for over 30 years, Paul Goodwin has been a member of the Cabot investment team and chief analyst of Cabot China & Emerging Markets Report since 2005.

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