I ran into this graph couple months ago and it just made me smile:
Unsophisticated retail investors entering the market, when they hear that their neighbour bought a new Beamer with their successful investments. Sounds like a familiar story right? This article about a Chinese housewife buying the penny stocks because they are the cheapest and hence have the most upside, made me already more worried than amused. If you cannot read, I do not think you should be trading on your own. Like Malkiel claimed, it doesn't necessarily take a genius to be able to beat the experts in the equity markets, but investing is not only about choosing companies. That is why this graph can explain what is happening:
Even if I would let a monkey build my portfolio by throwing darts, I would not use that approach to define how much leverage I take. How can an illiterate investor understand, what happens once he buys on margin and the market starts tumbling. It is a washing machine, as a surfer would say. Huge margin debt and a greater fool theory -driven market is a horrible combination.
Next you naturally ask, how is this gonna fold out? If you think about it with a common sense, this should end when the local big guys start seeing the value again, while the retail guys just have to enjoy the ride. The A-shares have been trading with a premium to H-shares since late last year (according to HSAHP index) as the retail investors have been rushing in to the mainland equity market. It hit an all-time high at 142.88 on June 10th. Just about when the current bear started showing its claws. It is currently at 124.53, but you can argue there is still room for further correction. The P/Es were almost double compared to the H-shares in the beginning of June. Eventhough the market structure makes it a bit complicated to compare, the differences should certainly not be that big. Especially, when China wants to eventually open up their economy to take their power to the next level. Once this happens, the HSAHP should be steady at 100, or so you would think.
So what do the Chinese think right now? Some retail investors are probably discovering what investor protection means, that is if they know how to spell it. The Chinese government on the other hand is probably wondering how to get more traditional cash from under the mattresses into the equity markets to replace some leverage. They might also be bummed, as this further shows MSCI that China is simply not ready to get into the game yet. Despite the China representing a large proportion of worlds GDP, the representation in security indices is still minimal. An argument the china bulls often bring forward.
So eventhough the China consumers' huge cash positions and the possible massive inflow of passive dumb money after an inclusion in the indices create interesting potential in long term, these kinds of market developments do not help matters. Therefore, if you decide to stay in China, you have to keep buckled up, and maybe even start holding your seat. If you like the story long term, it just makes more sense to look at the ETFs that stay in H-shares, since the premium should not be sustainable in long term any way.
And when you're feeling like a Monday tomorrow, remember that simultaneuosly there is a Greek not getting money from his ATM to buy morning coffee. You might still have that privilege.
-Emerging Chap
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