But as good as markets are at rational discounting in the face of a crisis, they are definitely not good at handling two crises at once. So when the Chinese stock market began to implode last week—the result of a year of speculative buying by Chinese investors and the government’s unexpected tightening of margin requirements—the result was extreme. Like a man under attack from a pit bull at his ankles and a swarm of bees around his head, a bit of panic was understandable.
The reaction from alarmed investors has pulled all of the major market indexes below their 25- and 50-day moving averages and back into the lower parts of their multi-month trading ranges.
For China and emerging market investors, this drop has been especially dramatic, as this chart of the PowerShares Golden Dragon Halter USX China ETF (PGJ) shows. (The Golden Dragon tracks Chinese stocks that trade on U.S. exchanges as ADRs.) How long will this correction last and how deep will it go, I don’t know, and neither does anyone else, even if they’re willing to offer predictions anyway. I’ve advised my readers in Cabot Emerging Markets Investor to sell two stocks and place three others on hold in response.
The chart shows quite clearly that March–April blastoff in those shares and the bumpier follow-through gains in May and June. The selloff last Friday and today is quite emphatic, and shows what happens when a two-front attack triggers investors’ flight reflex.
How long will this correction last and how deep will it go, I don’t know, and neither does anyone else, even if they’re willing to offer predictions anyway.
The important thing now is to cut your losses short, take at least partial profits in any emerging market stocks in which you still have them and avoid most new buying. There will be plenty of bargains around when this flood of negativity subsides, but trying to call bottoms in either the market or individual stocks is a loser’s game.
For Chinese stocks, capital preservation is the name of the game now. Once you have trimmed your portfolio’s sails to meet this new storm, you can relax and start building your watch list from among the casualties. But don’t even think of just holding onto everything and hoping that things will turn around quickly. Instead, respect the market’s action by raising some cash and keeping your stocks on tight leashes.