The Meltdown in Chinese Stocks: What’s Happening?

Chinese stocks may have even further to fall before they recover

The rout of the Chinese stock market has turned into a full-blown panic, and it has officially spread beyond the mainland-traded A-shares.

china-mapThe Deutsche X-trackers Harvest CSI 300 ETF (ASHR), which tracks Chinese A-shares, was down by as much as 11% this morning. But even the iShares China Large Cap ETF (FXI), which tracks Hong-Kong-listed H-shares and which has been mostly immune to the carnage in the Chinese market, was down by about 7% before noon.

It’s starting to look and feel a lot like 2008.

What’s going on here, and is this potentially one of those “blood in the streets” moments to buy when everyone else is selling?

Think back to 2008. It was scary, and there was no real way to know when we had hit bottom. Had you started tiptoeing back into the market in late 2008, you would have suffered another several months before the market finally found its bottom in March 2009.

So, I wouldn’t be in a hurry to jump into Chinese stocks just yet. But I would recommend you keep an eye on them, because I think we’re getting fairly close to a low-risk buying opportunity.

Let’s dig into the details.

What’s Happening With Chinese Stocks?

In a nutshell, you have a lot of leveraged traders liquidating their margined positions, which in turn drives prices lower and prompts more margin calls. It’s a classic case of selling begetting selling. Officially, about 9% of the market cap of freely-traded A-shares were held on margin, but the real number, allowing for dodgy shadow financing, is believed to be double or triple that amount.

What Is the Chinese Government Doing About It?

China’s leaders do not want to deal with the fallout of a major market crash. Growth is slowing, and the old Chinese model of making things cheaply and selling them to the West pretty well died with the 2008 crisis.

China’s plans to shift to a more consumer-oriented economy depend on healthy Chinese consumers and a sound banking system, both of which would be at major risk in a major bear market in Chinese stocks.

China has an unspoken pact with its people: The government delivers economic growth, and in exchange the people agree not to agitate for democracy. If things get bad enough, it could mean the end of the Chinese political system as we know it.

So, the Chinese government is pulling out all the stops. New IPOs have been suspended. Brokerage houses have been prodded into buying and holding over $19 billion in stock. Margin rules have been relaxed. And there is even talk of massive direct investment in Chinese stocks by the government via the state social security fund.

Why Isn’t It Working?

Frankly, these moves reek of desperation, and investors smell fear. And if you’re a leveraged holder of Chinese stocks, you’re no longer feeling greedy; you’re feeling fearful, and you’re going to take any opportunity you see to sell. China’s leaders couldn’t stop the slow leak out of the property market, and it’s unlikely that they will be able to halt a market panic.

So, with all of this said, should you consider an investment in FXI or ASHR?

Calling a bottom in a plunging market is impossible. No one — anywhere at any point in history – has ever been able to accurately call an exact bottom. Not here, not in China, not on planet Kronos — the home world of the Klingons from Star Trek.

But if Chinese stocks are cheap enough, might it be worthwhile to buy them now and wait it out?

Well, maybe. But let’s look at recent history as a guide. FXI peaked in late 2007 and then proceeded to drop 74% before finally bottoming out. ASHR wasn’t trading then, but its underlying index fell by a comparable amount. So, losses we’ve seen thus far in ASHR and FXI are pretty mild by the standards of a Chinese bear market.

Looking longer-term, there is a lot to like about Chinese stocks. Once China eventually meets MSCI’s standards, hundreds of billions of dollars in foreign capital will be sloshing into the Chinese stock market. And China, even with a potential “hard landing,” is still one of the fastest-growing economies in the world.

Chinese stocks will probably rally by hundreds of percent in the years ahead. But if you get in today, you run the risk of taking a lot of pain in the meantime. My advice is to be patient and wait for a lower-risk entry point.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/07/chinese-stocks-meltdown/.

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