Tuesday, October 20, 2015

Why I Am Not Buying Chinese Stocks After The Major Decline

Back in September of 2012 when the world had either forgotten or hated the Chinese stock market (which was trading at 2060), I wrote an article titled China's Stock Market Continues To Plunge: Buying Opportunity? I outlined the reasons why I had begun to purchase Chinese shares which centered around sentiment, valuation and my long term bullish outlook for their economy over the next century.

About two years later to everyone's surprise (including mine) Chinese shares began to accelerate upward rapidly and then went vertical. At the end of March with the market trading at 3822, I wrote an article titled China's Stock Market Continues To Soar: Selling Opportunity? I outlined the reasons why I was selling my shares which centered around sentiment, margin and valuation.

The market had essentially become the opposite of what it was in late 2012. Ironically, the Chinese economy was far stronger in late 2012 than it was entering the fall of 2014. This was another great lesson for me that markets in today's world (post 2011) seem to have less and less correlation with economic fundamentals.

As a quick side note, I am not trying to brag about my market "timing" with Chinese shares. In general, I am a pretty terrible market timer. I like to buy assets when they are cheap and hated and sell assets when they are overvalued and loved. That usually means I am very early to markets (I had to wait 2 years before the Chinese market did anything), and usually sit out for prolonged periods of excess and irrational exuberance (as the U.S. stock market has been in for about 3 years). The only reason I took action on the sell side was because the Chinese market had put in gains that would normally take about 10 years to occur over an 8 month period. The euphoria (which equals danger to me) had reached a perilous state.

Almost everyone knows the China stock market story following March 31, 2015. The market continued to move higher for a few more weeks, crossing over 5000, before it quickly collapsed back down to the 3000 range over the next two months.

The question I am often asked today is whether or not I would enter the market at current prices. In terms of valuation and sentiment I am essentially neutral on the market. It has rallied up to 3,424 as I write, bringing some brave souls back into the water.

The biggest change for me personally is what I watched occur during the market decline. Chinese officials essentially panicked, pulling out every measure you could imagine to stem the market's decline. They even went as far as to stop trading many of the stocks on the exchange.

One of the benefits to investing stocks in general is liquidity. Unlike a real estate asset which can take months to sell, stocks can be liquidated in seconds with a keystroke. It is part of the reason why investors (including myself) pay a premium to own stocks over other assets.

If Chinese regulators are going to turn off the ability to sell a stock at the first sign of a market decline, it essentially removes this liquidity premium. I have not heard them mention once they will allow the markets to trade freely in the future, which is probably because they are still terrified of further declines. Until I hear and believe they have made changes to this policy I will continue to be a spectator in their share market. If valuations and sentiment once again become too tempting to pass up (even with the liquidity premium removed) I will let you know I have once again begun making purchases.