Here’s Why China Stocks Are Still Doomed

China is a disaster in the making -- and it will get worse before it gets better

The Greece referendum and resulting market turmoil is the talk of the market after the long holiday weekend. But while Greece is worth watching, the future is hardly clear. While a “grexit” is indeed possible, so is debt relief and a continued membership in the euro currency area.

Here's Why China Stocks Are Still DoomedOf course, doom-and-gloomers see the destruction of Europe as the only inevitable conclusion. But that’s a gross oversimplification of a complex issue with the currency area and its debt-crippled member states that still must play out.

So if you really want to be a negative Nancy, I’d suggest less hand-wringing over Greece and much more panic over China.

Because China stocks are a disaster waiting to happen — and it will get worse there before it gets better.

China Stocks Will Keep Crashing

This year started with a huge run-up in China stocks on hopes of a stimulus juicing the economy. But as a result, there has been a stampede of buying that has resulted in tremendous froth.

The vertical climb in stocks has created bubble-like valuations — including tech stocks that traded for more than 220 times forward earnings on average near the peak!

We’ve started to see this bubble loose some air lately, with Shanghai stocks in bear-market mode with a 20% slide from the top. That includes a one-day loss of 7%, illustrating just how volatile this China stock market is right now.

But there’s more pain ahead, to be sure.

The problem is that the increase in China stocks has come with a huge increase in leverage, including a staggering increase in margin debt as Chinese investors borrow tons of money to get into the “sure thing” market. Money-hungry corporations are also racing to get in on the party, with a frantic IPO pace that has delivered 225 new companies to market since January 2014 — with an average performance of over 400% since they hit public markets!

At least, before the crash that is.

This, even as A-shares listed on Shanghai and Shenzhen exchanges are predicted to have the lowest earnings growth in three years — with the financial sector, struggling amid bad debts, acting as one of the biggest drags.

None of that is good. But throw in the general untrustworthiness and opacity of China’s command-and-control government, and it’s very difficult to think this will end well.

There may be a way for China to avoid disaster for the short term. After all, its central bank has cut rates three times in the past six months and is launching stimulus “to help local governments restructure trillions of dollars in debts.”

But this party last, and investors have already started to bail out. The iShares FTSE/Xinhua China 25 Index (FXI), one of the largest China ETFs, is down 10% in the last month. Worse, the Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF (ASHR) that invests only in China-listed stocks instead of NYSE and Hong Kong issues is down more than 20% in the same period.

If you’re thinking of catching a falling knife in China, don’t. These losses should only be the beginning as debt problems and a slowing economy lead to prolonged difficulties for stocks here.

Look at the race to the exit in China fund flows over the past week as proof that Wall Street expects this to get worse before it gets better; stay smart and steer clear of China stocks for now.

Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. 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/heres-why-china-stocks-are-still-doomed/.

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