While markets decided to ignore what are destined to be doomed attempts to cover over intractable debt crises in Greece and China, the real action in the markets last week took place in two high-flying NASDAQ stocks - Netflix, Inc. (NASDAQ:NFLX) and Google, Inc. (NASDAQ:GOOG).
Netflix stock split 7-to-1 and the company announced strong subscriber growth, pushing its stock up from a split-adjusted $98.13 on Wednesday to $114.77 at the end of the week. The 18% pop increased its market cap to $48.7 billion and its price/earnings ratio to 210x as Wall Street analysts competed with each other to raise their price targets to ever higher levels.
If you think that sounds giddy, look at what Google did...
The Stocks Driving the NASDAQ This Week
But Netflix's gains paled in comparison with those of Google, whose stock market capitalization gained an extraordinary $65 billion in a single day after the company announced better-than-expected second quarter earnings and hinted at possible stock repurchases or future dividends and showed spending discipline for the first time.
GOOG shares rose by $93.08 per share on Friday to a record $672.93 per share, giving the company the second largest market cap of any company after Apple, Inc. (NASDAQ:AAPL) of $468 billion.
These stocks dragged the NASDAQ Composite Index (INDEXNASDAQ:.IXIC) to a new record high of 5210.15, rising 4.3% or 213 points on the week. The Dow Jones Industrial Average (INDEXDJX:.DJI) jumped by 2% or 326 points to 18,086.45 while the S&P 500 (INDEXSP:.INX) rose 2.4% of 50 points to 2125.64.
Investors laid aside worries about a possible Greek exit from the Eurozone despite the fact that such an exit would in fact be well-advised - both for the Greeks and the rest of Europe. The deal that was reached after torturous negotiations does virtually nothing to pave a path for Greek solvency; it includes no debt relief and its first move was to lend Greece another €7 billion that it can't afford to pay back to repay loans on which it recently defaulted.
Greece's economy will now sink deeper into depression while Europe's politicians can stick their heads deeper into the sand until reality comes and chops the rest of their bodies off.
Meanwhile, China picked an awkward time to try transparency for a change.
About Those China "A" Shares You've Been Waiting For
Investors also ignored the fact that China no longer has functioning stock markets or that the collapse of China's stock market could have a serious negative impact on that country's economy.
The government has outlawed selling by pension funds and other large investors and allowing half of all listed companies to suspend their shares from trading. When they weren't taking those steps, the government was threatening short sellers and journalists with imprisonment. Such measures never work and if the market ever re-opens to normal trading, selling will resume with a vengeance.
Any dreams of China' "A" shares being included in global stock indices will now be delayed for many years. Like Greece, China is suffering from a massive debt crisis. According to the McKinsey Global Institute, total debt in China increased from $7 trillion before the crisis to $28 trillion today.
Much of this debt was funneled into the property market, then into various types of debt products sold through China's shadow banking system, and finally into the stock market over the past year as the first two plans ran out of gas.
The stock market bubble was aided and abetted by an enormous amount of margin debt, which tripled since June 2014 and hit nearly 9% as a share of tradable stocks, the highest in any market in history according to Morgan Stanley's (NYSE:MS) Ruchir Sharma.
An incredible two-thirds of China's 90 million retail investors lack a high school diploma and trading activity can only be described as manic; on many days during the period leading up to the market crackdown, total volume exceeded that of the rest of the world's markets combined.
The median valuation of stocks on the Shanghai and Shenzhen exchanges was almost triple that of the S&P 500 even after the recent plunge in prices. Some Wall Street analysts were still recommending Chinese stocks and trying to rationalize Chinese stock prices as the market continued to hit new highs, and some are even recommending them now based on their belief that the authorities will succeed in saving the market.
Such views are reckless and should send a warning sign regarding similar advice to buy parabolic social media and biotech stocks.
The question now is how badly the market sell-off will hurt China's economy. Most market commentators downplay any impact arguing that China's stock market only has a limited impact on the country's economy. While China's stock market has not correlated with China's economic growth, I would not so easily dismiss the current market sell-off for several reasons.
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What China May Be Hiding From the World
First, Chinese regulators have turned the sell-off into something much more significant; their market interventions have damaged the confidence of foreign investors in the market, significantly delayed the inclusion of China's "A" shares in global stock indices, and effectively rendered China's stock markets inoperative as markets.
Second, China's stock market has been serving the purpose of absorbing excess liquidity flows that were previously directed to other areas of the economy as part of China's central economic planning. Those other areas ran out of steam, and now so has the stock market. This is bound to have a negative feedback loop on consumption and the servicing of debt that was already negatively impacting growth.
Third, Chinese growth was already likely well below 5% despite "official" figures claiming it is still 7% or so (and when a government makes a special point of telling you that its economic data is correct, you know that the opposite is true1). Even if the stock market decline only has an effect at the margins, it is having that effect at a time when the economy is particularly vulnerable. A combination of factors hurting growth could combine into a tipping point that hits China hard and with it the rest of the global economy that has been depending on China as the engine of global growth since the financial crisis. The fact that few have bothered to comment on the fact that this engine has been fueled by massive debt growth suggests that many are overlooking the challenges now facing the global economy.
China is not the only centrally-planned economy in the world; it is just a more extreme version of how economies are managed in the West in a post-crisis environment. Sooner or later, all central planning fails.
If China fails to stabilize its stock market - which is most certainly will fail to do - this will be a blow to all central banks who have effectively been propping up stock markets around the world.
While China's case was more extreme than what has been happening elsewhere, it should serve as a warning sign that central banks can only manipulate markets for so long. Fundamentals do matter and debt eventually has to be paid back, inflated away or written off. When that happens, stocks will stop rising to the moon even if they promise the future like Netflix and Google.
China's National Bureau of Statistics spokesman Sheng Laiyun stated that "China does not underestimate its GDP deflator and we don't overestimate its GDP." That statement has about as much credibility as the Obama administration's early promises that the Iran nuclear deal would provide for "anytime, anywhere" inspections of Iran's nuclear facilities.
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Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.