China's stock market pattern is beginning to remind me of Japan's "irrational exuberance," as witnessed in the early nineties where a decade of fantastic growth was followed by a decade of flat to lower stock prices. I struggle many times with why investment dollars flow to a country with serious human rights issues and a government that borders on oppressive. But the fact remains that China's GDP growth north of 10 percent in the last few years is big enough to wake Chinese philosopher Confucius out of the grave to take notice and teach us a few things. Confucious once said:
In a country well governed, poverty is something to be ashamed of. In a country badly governed, wealth is something to be ashamed of.
High energy demand and pricing, a lack of corporate governance and financial accountability to shareholders, hard-lined policies with respect to a free market currency and unfair trade practices are sure to bring the flying dragon down to earth. Investors should remember the events of 10 months ago when a one-day 9% meltdown in Chinese stocks rippled around the world> sparking a 400 point sell-off in the Dow Jones Industrials. Since then, there have been two other sell-offs in Chinese stocks this year following the US Market's lead. Confucious said:
He who sacrifices his conscience to ambition burns a picture to obtain the ashes.
As I write this post, China's Hang Seng Index dropped overnight by 716.45 points (or 2.42%). This follows a sharp rise in the prior two sessions of nearly 2 percent. When one sees this kind of volatility near the all-time highs, it's time to get cautious or face the music when something bad happens. Confucious said:
He who will not economize will have to agonize. Much wealth will not come if a little does not go.
There exists well documented over-valuations of stocks that exist in this market as is evident by the recent PetroChina deal> that came public. Even Warren Buffett made a killing on this deal, but he was quoted recently saying that finding a similar great deal in China now was a struggle in China's "too hot" stock market. Warren Buffet's words of wisdom:
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful. It's only when the tide goes out that you learn who's been swimming naked.
He, like some other Wall Street mavens, have started to realize that China is overvalued. However, either there are not enough analysts out there to warn investors, or maybe they are just walking as blind as last year's bond ratings agencies that failed to warn us of the sub-prime mortgage crisis. Maybe the big Wall Street firms are afraid to tell the truth for fear that their mega-million dollar Chinese IPOs will come to a crashing halt if they get too bearish on the region. It does happen, you know. Laurence J. Peter (1919-1988) once said:
An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today.
China now faces 6.5% inflation, a ten year high and, as if that weren't enough to create some headwinds, an under-publicized energy shortage.> This crisis has certainly been the driving factor behind oil's price rise to boiling temperatures, and there seems to be no end in sight (for the record, I am still playing the volatility in oil with neutral options positions). Economist writers have forecasted slower growth ahead for China.
Confucious:
Ability will never catch up with the demand for it.
George Gobel:
If inflation continues to soar, you're going to have to work like a dog just to live like one.
I am initiating a position in the Proshares Ultrashort FTSE/Xinhua China 25 (FXP – AMEX), a newly launched ETF that is designed to double the inverse daily return of Chinese stocks listed in the FTSE/Xinhua China 25 Index. It closed yesterday at $62.10 and will probably open much higher at the open, but for investors looking out 6-9 months, this represents a great way to play Chinese stocks to the downside. I didn't have the luxury of ETFs that short the market 15 years ago when Japan's market fell out of bed, but I see another opportunity now and the instrument to do it.
Confucious:
By three methods we may learn wisdom: First, by reflection, which is noblest; Second, by imitation, which is easiest; and third by experience, which is the bitterest.
To all the Chinese investors reading this post, I have high hopes for China in the distant future as an investment. But near-term leading up to the Olympics in August, I see a major correction coming in this market, which will by then make Asian stocks attractive again. As Confucious said:
Our greatest glory is not in never falling, but in rising every time we fall.
As for all the other novice investors who have been jumping into the Chinese market over the last few months, Confucious has words of wisdom there too:
Man who run behind car get exhausted. Man who run in front of car get tired.
Virginity like bubble. One prick – all gone!
Disclosure: I will be adding a new position in FXP on the next up day in the Chinese market.
Photo:Rob Web, Creative Commons, Flickr