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You've heard the stories about the 1929 stock market crash, how investors should have figured out that, when taxi drivers and shoe-shine boys hawked stock tips, the end was near.
The lesson we're supposed to have learned was that cheap margin – the debt that investors can use to finance stock purchases, when wielded by uneducated, blindly optimistic "plungers," can drive stocks up and up over a cliff into an abyss.
Too bad the Chinese never got that memo.
China is now facing a 1929-style stock market crash thanks to rampant margin buying by millions of new investors who believe the market is the road to riches.
But it's not just Chinese plungers or the Chinese economy that's going to suffer.
A 1929-style crash in China will send shock waves around the globe and to your door.
Here's what's really happening and what you can do to protect yourself and even profit from the fallout…
Up, Up, and Away
There are three principal Chinese stock markets: the Shanghai Stock Exchange, where most big company "blue-chip" stocks are traded; the Shenzhen Stock Exchange, where some big and mostly middle-market company stocks are traded; and "China's Nasdaq," known as ChiNext, where mostly small, speculative companies trade.
Stocks on those exchanges, after running up wildly over the past 12 months, are now all selling off.
The Shanghai Composite was up over 100% in the past 52 weeks. It's still up 83% according to optimists, who prefer not to admit it plunged 26% in the last three weeks. The Shenzhen is down almost 30% in the same few weeks after being up 150% in the past 52 weeks and up 60% just since January 1 of this year. The ChiNext is now down 40% from its June highs.
New "investors" are mostly to blame for the run-up and the sell-off as they get hit with margin calls as prices topped out and began falling.
The Perils of New Money
Millions of Chinese have been opening up brokerage accounts and taking the market plunge.
According to the China Securities Depository and Clearing Co., in the last week of April, nearly 1.7 million new brokerage accounts were opened across China. Over a two-week period earlier in April, 2.4 million new accounts were opened. On average, since the beginning of 2015, almost 170,000 brokerage accounts a week have been opened.
Most of the new accounts have been opened up by many of China's least-educated investors.
According to data compiled by Bloomberg, there's a big difference between "Existing Investor Households" and "New Investor Households."
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.
Okay.
By uneducated do we mean lack of Junior High, Senior High or University Education?
Or do we mean lack of Education in Investing?
We all, are aware of the guy who works in the mail room of a company who then becomes a Mogul or Diva of Industry!
Maybe by education we mean some time in the mail room?
I heard that a lot of these investors are Chinese Farmers – it seems to me that if one is a success at farming in China then it should give one some 'Street Creed'!
BUT THAN THERE IS THIS CHINESE LOVE OF THE GAMBLE!!
I am not quippling with putting the blame on the uneducated even though the commentators that hold this view don't seem to feel a shred of compulsion to be more precise.
Perhaps a little more respect for the proletariat here?
Thanks for writing, Leslie.
By no means do we want to "bash" the people. Quite the contrary, our philosophy is that we all – wherever we live, however much we have – have the power to become savvy investors and take our own financial destiny in hand.
But, as happened here in the U.S. in 1929, the "average" Chinese investor is, in a sense, being preyed upon, encouraged to leverage to the hilt and "put all their eggs in one basket." If you're a longtime Member and a fan of Shah's, you know that he's got strong medicine and tough love for individual investors, but he's absolutely merciless to the predators who manipulate markets to enrich themselves at the expense of the unwitting.
Thanks again for writing. – The Ed.
Great article and thanks.
Ive been in cash for a while now not finding anything remotely interesting and then wham SDS comes along…
Timely?
Shanghai Comp up 3709pts!
Not today but most definitely when the S+P 500 nears its highs again.
Many thanks for the SDS recommendation.
PS. I love your style Shah!
Thanks, Gabriel! Let is know how you do with it. – The Ed.
So how do I profit from this crash?
The Chinese are said to like gambling even more than sex.
I profited thousands this way: When I saw two straight days of big China market losses, I knew the margin calls would come. I also knew scared, rookie investors in China would not understand the concept of dollar cost averaging. So I knew for certain they would want to sell off in a dip. So I purchased the triple inverse leveraged etf YANG. I made most of my money there. When I heard the Chinese government were going to purchase stocks, ban major shareholders from selling, and allow 75% of companies to halt sales of their shares, I saw the writing on the wall. I knew then the market over there could only go up at that point. It would go up artificially, but it was certain to go up. After all, no one could sell their stocks in 75% of the companies, no major holders could sell, and the government would create increase in demand where their was none. So I sold off YANG and purchased the triple leveraged China bull ETF YINN — I Did not make as much off of YINN, but I still pulled in a significant sum. These were probability plays. There was a high chance that these two plays would work out due to the way the market works when it is free (when it began to crash), and the way it works when it is being manipulated (when gov stopped crash). So, there are opportunities everywhere in any market. You just have to seek them out.
Like with all investments, one must perform their due diligence and have the insight to become contrarian. The gamble of securities is to understand history and be able to predict. Short term investing does not allow the investor to become invested in the sector/business. Pity. They lose out on the value and enjoyment of investing, thus impacting greater profits.
The site: http://www.theage.com.au/business/markets/signs-of-growing-hush-in-chinas-economy-20150712-giag7x.html
Gives a different picture about who is behind the stock market in China than the article above does.
"The recent China Household Finance Survey at the Southwestern University of Finance and Economics in Chengdu, China, found that only 9 per cent of households actively traded shares. Some 6 per cent of these stock traders borrowed money to do so, said Li Gan, a professor at Texas A&M University who has helped design and oversee the survey. Another 4 per cent of households owned mutual funds.
He said the survey found that most individual investors had responded calmly to the drop in share prices and had begun trimming their positions carefully. He blamed the speed of the stock market's decline, and sharp reductions in margin debt, on what he described as a relatively small group of extremely wealthy investors who had taken big risks with mostly borrowed money.
Read more: http://www.smh.com.au/business/markets/signs-of-growing-hush-in-chinas-economy-20150712-giag7x.html#ixzz3ffBphKTq
So it is according to this not any uneducated investors who are behind this but a small group of extremely wealthy investors. Would be interesting to know why the opinions difffer so much about who is behind this ?