Historical Similarities Are Not Guides for China and Greece
Thursday, July 9, 2015

This summer has not been kind to the Chinese markets. Since mid-June, nearly 30% of the market capitalization of Chinese stocks has vanished into the ether. (The Shanghai Stock Exchange Composite is down by about 28% since June 12, 2015.) Reuters says trading halts have been placed on about 1,500 stocks listed on the Shanghai and Shenzhen exchanges. To put this number in perspective, the value of these companies equates to about half of the Chinese market.

This downward plunge would normally dominate the financial headlines. However, another problem several thousand miles to the west has been taking up space on the front page: Greece. Last Sunday’s “No” vote on the austerity referendum has left the country’s and the eurozone’s future in question. In a sign of the times, yesterday an acquaintance of mine said to me, “You must be pretty busy with what’s going on with Greece.” No mention of China. My assumption is that he’s not alone.

I’m not going to say much about Greece, other than that it’s a small country and its problems have been well-known for years. Beyond that, anything I could say would be pure speculation. I simply don’t know what is going to happen, and neither does anybody else. An Italian newspaper quoted European Central Bank President Mario Draghi describing the odds of finding a solution as “I don’t know, this time it is really difficult.”

History is not giving us much insight either. Business radio program Marketplace said that the last example of a unified currency falling apart was the Habsberg Empire’s gulden and krona, which lasted from the 1750s to around the end of World War I. Given the changes that have happened since then, it’s far from an ideal example to rely on.

History is also being used to draw parallels between China and the United States. Bloomberg published a chart last week comparing this year’s movement in the Shanghai Composite to the Dow Jones industrial average movement in 1929. The headline of the article was, “China Brokers Dust Off Wall Street Playbook From 1929 Crash.” The Wall Street Journal quoted a 32-year old college art teacher in Nanjing, Sophie Wang, as saying, “I don’t really follow news on stocks that closely. My hairdresser said it was still a bull market and I needed to get in.” The quote conjures up images of the ticker tape machines reportedly installed in some U.S. hair salons during the 1920s.

As strong as these comparisons seem, there are very big differences. China’s central government exerts a strong influence over its economy and the financial markets, unlike the U.S. government—particularly in the 1920s. Margin requirements are higher in China than they were in the 1920s United States. Earlier this year, The Financial Times said that Chinese regulators require an initial margin of at least 50% with a minimum account balance of Rmb500,000 (about $80,000 in U.S. dollars). Reuters reports the Chinese government as now barring shareholders from owning more than 5% of a company’s stock and from selling shares for the next six months, suspending initial public offerings (IPOs), easing margin terms, enlisting brokers to buy stocks and investigating “malicious” selling of shares by short sellers.

The government’s involvement does not change one important fact, however: China has many relatively new investors who likely lack any knowledge of global market history. While it may be tempting to snicker at Sophie Wang’s hairdresser’s comment, the reality is that the capital market system is still fairly new in China. The country has not experienced the type of capitalist booms and busts the U.S. has. Plus, it’s unclear how many books about asset bubbles and financial busts (such as Charles Mackay’s classic “Extraordinary Delusions and the Madness of Crowds”) are available, much less read, on the mainland. In other words, there are a lot of investors in China, like Sophie Wang, who are unaccustomed to the big downward moves.

As scary as the moves in China look, the good news is that so far there has not been global contagion. Rather, correlations between Chinese stocks and global stocks are just slightly above zero, after previously having been negative, according to a chart tweeted by BlackRock today. While commodity prices have been hurt, the national indexes of other large economies—including the U.S. and Japan—have not been affected overall. Given the Greek crisis, it is very difficult to discern any impact on the European markets from China. As far as other BRIC indexes go, Brazil, India and Russia have all been struggling with their own internal issues, making it difficult to attribute any weakness directly to China. (To be fair, Brazil has been impacted by weakness in commodity prices, but the country is also coping with domestic political issues too.)

It’s also worthwhile to note that China’s economy is still growing at a pretty good pace, and market drops tend to be comparatively short-lived. The drops are painful, but shorter in duration than upward moves. These facts will likely not make headlines right now (nor will the size of Greece’s economy relative to the rest of the European Union and the world), but they are worth keeping in mind.

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The Week Ahead

Nearly 40 members of the S&P 500 will report earnings next week as second-quarter earnings season starts to warm up. Included in this group are Dow Jones industrial average components Johnson & Johnson (JNJ) and JPMorgan Chase & Co. (JPM) on Tuesday; Intel Corp. (INTC) on Wednesday; Goldman Sachs Group (GS) and UnitedHealth Group (UNH) on Thursday; and General Electric Company (GE) on Friday.

The first economic reports of note will be June retail sales, June import and export prices and May business inventories, which will be released on Tuesday. Wednesday will feature the June Producer Price Index (PPI), June industrial production and capacity utilization, the July Empire State Manufacturing Survey and the Federal Reserve’s periodic Beige Book. The July Philadelphia Fed survey and the National Association of Home Builders July housing market index will be released on Thursday. Friday will feature the June Consumer Price Index (CPI), June housing starts and building permits and the University of Michigan’s preliminary Consumer Sentiment survey.

Federal Reserve Chair Janet Yellen will give her semiannual monetary testimony to House and Senate committees on Wednesday and Thursday, respectively. Cleveland president Loretta Mester and San Francisco president John Williams will also make public appearances on Wednesday.

July stock options will expire on Friday.

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AAII Sentiment Survey

Neutral sentiment remained above 40% for a 14th consecutive week in the latest AAII Sentiment Survey. Additionally, optimism rebounded as pessimism pulled back from last week’s 2015 high.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 5.3 percentage points to 27.9%, a three-week low. The large drop keeps optimism at an unusually low level for the ninth time in 10 weeks. This is also the 18th consecutive week with a bullish sentiment reading below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, edged up 0.6 percentage points to 42.9%. The increase keeps neutral sentiment above its historical average of 31.0% for the 27th consecutive week and at an unusually high level for a 14th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, pulled back by 5.9 percentage points to 29.2%. The historical average is 30.0%.

The current 14-week streak of neutral sentiment readings at or above 40% (readings above 39.6% are unusually high) is the first such streak since July 8 through October 21, 1988. If neutral sentiment is at or above 40% next week it would tie the record set between November 13, 1987 and March 4, 1988.

Optimism is also in the midst of a notable streak. The current stretch of 18 consecutive weeks with below-average readings is the longest since a 20-week stretch between April 5 and August 16, 2012.

Notable upward and downward moves in bullish and bearish sentiment have been occurring over the past few weeks as the S&P 500 has been showing signs of becoming more volatile. Greece is at the forefront of some individual investors’ minds, as we are seeing it mentioned with a greater frequency in response to the survey’s special questions. The timing and magnitude of a change in U.S. monetary policy is still taking precedence, as we noted last week. Contributing to bearish sentiment are concerns about the possibility of a bigger decline in stock prices occurring, the pace of economic growth, the lack of wage growth, valuations, the impact of the stronger dollar on earnings and geopolitical events. Contributing to bullish sentiment (in addition to still-accommodative monetary policy) are the ongoing bull market, sustained economic expansion and earnings growth.

This week’s special question asked AAII members what they thought about the limited volatility experienced by the large-cap U.S. indexes during the second quarter. Responses were very mixed. The largest group of responses (14%) believe the decline in volatility is a precursor to a downward move in stocks. A nearly equal number (also about 14%) pointed to a lack of catalysts to move stock prices in either direction. Nearly 9% said the lack of volatility is not influencing how they view stocks. The uncertainty of when the Federal Reserve will begin to raise rates was cited by 7% of respondents. Slightly more than 6% said the low volatility will not last, though they are unsure in what direction stock prices will move. An additional 6% viewed the lack of volatility as a positive sign. Five percent perceive the market or the individual stocks they own as having been volatile.

Here is a sampling of the responses:

  • “I don’t think it’s important to what happens to stocks moving forward.”
  • “Few alternatives for return, but investors are not overly anxious to increase their position in equities.”
  • “I thought there was plenty of volatility and I would not have wanted more.”
  • “The market seems to be consolidating, but what direction is the next major move?”
  • “It is setting us up for a 10% to 15% correction.”
  • “No one knows what to do.”


This week’s Sentiment Survey results:

Bullish: 27.9%, up 5.3 points
Neutral: 42.9%, up 0.6 points
Bearish: 29.2%, down 5.9 points

Historical averages:

Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!