Valuations in corporate debt and equity markets have been loony bin for many months. Apart from a brief retrace to fair value in the spring of 2009, most security prices have made no fundamental sense since at least 2011 when the world economy turned down once more, and central banks went into a panic of QE experiments and corporations doubled down on ‘engineering’ earnings by buying back their own inflated shares.
Still, many outsiders have continued to pile in new capital along for the ride, glad-handed all the way by throngs of financial folks happy to make a sale. But the trouble with buying dangerously overvalued assets is that it’s the opposite of investing; it’s speculating, and what speculating give’th it eventually take’th away and more. Chinese participants are learning this lesson encore this week, first hand. After soaring more than 100% in the past year, Chinese stocks are a recent example of all that is messed up in financial markets. Plunging growth and soaring credit risk sparked a mad rush for margin debt and reckless bets among regular people hoping to ‘get rich quick’.
And then like a thrill ride at a theme park, Chinese markets dropped 20% in the past two weeks to the shock of sheep-like participants. This is most likely just a starter. It takes a drop of 50% to take back 100% of the previous increase, and before this correction is over, we should see much further downside. Of course, because they were highly levered, many gamblers have already been forced to liquidate in tatters. Chinese losses offer a warning shot to others still ‘playing’ in extremely overvalued developed markets.
Wang Yan is starting to regret that day two months ago when she gave into temptation and piled into the Chinese equity market.
“Back then, I thought I must be stupid not to invest in stocks as making money out of it was so easy,” said Wang, 26, who works for a publisher in China’s eastern Zhejiang province. “Now I think I’m even more stupid. The money I lost almost equals my one-year salary.”