I don’t have a stock market crash prediction for 2015 on this side of the world, but something is troubling me regarding a stock market over 7,000 miles away: in China.
While you may have little or no capital invested behind the Great Wall, you should still be aware of the deeper problems brewing in the country’s capital markets, which remind me of how the Wild West emerged here. A sinkhole is quickly developing amongst Chinese stocks that could have devastating effects on domestic stocks. Never mind the interest rate risk; just watch China.
A few weeks ago, index developer MSCI Inc. (NYSE/MSCI) was evaluating whether to add the highly speculative but surging China A-shares to its global indices equation. MSCI surged on this possibility, as it means access to the high-flying Chinese stock market. However, it subsequently backtracked, after deciding not to add the shares at this time.
Investors on this side of the Pacific were excited about getting in on the Chinese A-shares, which are not available for foreign investors except through special investment vehicles. The A-shares are found on the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
Think about the fact that the Shanghai index has been up over 140% over the past 52 weeks and you’ll understand why investors here are anxious to partake.
Chart courtesy of www.StockCharts.com
Why My Market Crash Predictions for 2015 Involve China
Simply put: stock market parties don’t last forever. Just think back to 2000 when the technology and Internet sectors imploded and wiped out people’s life savings.
Make no mistake; Chinese A-shares are trading at extremely frothy heights that would please Boeing. The fact is: China is slowing on many fronts. Yet the stock market sizzles.
The reason why is pretty simple. We have tens of millions of speculators trading the Chinese A-shares with little knowledge on the stock market dynamics. Instead, they treat the capital markets as if they were gambling in Macau.
The point is that the People’s Bank of China (PBOC) has allowed the explosion of margin finance in the country to anyone wanting to invest in the stock market. This easy money is akin to the easy money that resulted in the subprime mortgage meltdown in this country.
If you are not worried, let me tell you why you should be.
As of April, there was about $264 billion in margin loans to investors in China. While the PBOC and China Securities Regulatory Commission are clearly nervous about the situation, the reality is that the margin is out there. It is thus a significant risk to a bubble brewing that could likely drive a stock market crash sometime this year.
Just think about the massive finance margin that helped drive up stocks to euphoric heights in 2000. We all know what was to come. The same will likely occur in China; and you’d better be prepared, as it could be massive and cause a global stock market contagion.
We are seeing the dumping of Chinese stocks by senior executives and family members that accounted for 1.68 billion shares in May. (Source: Chinaeconomicreview.com, June 15, 2015.) If this is not a red flag, then I’m not sure what is.
How Traders Can Benefit From this Situation
Traders can use put options or shorts to benefit from a possible Chinese stock market meltdown.
Vehicles include the Deutsche X-trackers Harvest CSI300 CHN A (NYSEArca/ASHR) exchange-traded fund, which holds the volatile A-shares. The ETF is up 140% from its low, so it may be primed for a sell-off.
Another option would be to play the downside of the domestically listed iShares China Large-Cap (NYSEArca/FXI), which has also been on fire.