The next move is clear now

It is really brutal and scary for this stock market. It had been holding above the important support level of 3000 for two years but finally it broke down and was approaching the lowest point since after the epic crash 4 years ago. By now I hope you can guess which stock market I’m talking about. Yes, it is the Chinese stock market. Since reaching to the bottom around 2760 (the Shanghai index) in early 2016, it has been slowly recovered in the past two years, up about 30%. The sentiment has improved and it seems the stock market is entering a sustainable recovery for long term. Then all the sudden, the floor is falling apart and the Shanghai index has tumbled towards the 2800 level now. It is not news that this is largely due to the trade tension with the US, which seems to be escalating every day.

 

While the stock market can move around reacting to headline news every day, China is facing some fundamental issues for its economy. Although I’m not an economist here to do a deep dive analysis on the Chinese economic problems, at least I understand two gigantic bubbles are created in China that must be handled very carefully: the debt crisis of all levels (governmental, corporate and personal) and the sky-high housing bubble. Needless to say, the Chinese government is crystal clear about the huge problems they are facing and is actively looking for solutions that are hopefully will only lead to a soft landing. But it is a super difficult task for any government to handle. Historically there are two examples (Russia and Japan) with two macro strategies for trying to solve the issues: Russia which resorted to give up its currency to protect its housing market. For Japan, they gave up their housing market to keep their currency stable. Both has resulted in terrible outcomes with deep economic crisis for decades. Is there a third option for China to try? I hope yes but I’m not smart enough to figure it out. Without knowing for sure, it seems to me the most likely approach for China is to try to protect the housing market as understandably an immediate crash of the housing market may likely cause significant social turmoil, which is not acceptable by any means. On the other hand, letting the currency RMB depreciated won’t immediately cause turmoil for the society although its ultimate result won’t be pretty as well over the long run as it will boost inflation and reduce investments and further increase debts. But there is no easy way out and a choice has to be made between the two. Apparently we have got a clear sign by now. The central bank of China has announced to drop 0.5% required reserve ratio for commercial banks to boost lending, adding over $100 billion liquidity to the financial system. I think this is a start of a new round of QE in China with a hope that the economy will be soft landing with the debt crisis being tapered down gradually.

 

Given the history that did not paint a pretty picture for either choice, I’m indeed very worried about ultimate outcome for the China’s economic development in the long run. As summarized here by my son, some internal voice from the top has sent a clear worrisome message that the potential of a “financial panic” in China is very real and should not be ignored.  But in the short run, meaning the next few months or even a couple of years, I think the new QE programs will boost asset classes including stocks and housing markets. Although the past two months have been brutal for the Chinese stocks that have slipped into the bear market territory after tumbling over 20% by now, I think there is a good chance to bet for an uptrend for the Chinese stocks as well as housing market for the foreseeable future after the selling is exhausted and the bottom is reached (which should be near).  Be clear, I’m not talking about long term investment here but as a trading idea. Don’t be too bearish just yet for China! The ongoing trade tension with the US, while could be scary on the surface, is just noise. China is just too big and powerful now for it to simply go crash and it will manage to thrive as long as possible. I just wish it could find a reasonable way out for its long term prosperity without following the footsteps of Japan and Russia in tackling the humongous debt and housing problems. Good luck, China!