Chinese stocks plummeted again yesterday.
The Shanghai Composite tanked 8.48% to 3,725.56, while the Shenzhen Composite fell 7% to 2,160.09. And the ChiNext, China's smaller equivalent of the Nasdaq, fell 7.4% to 2,683.45.
Based on everything the Chinese government and regulators have done to stem the sharp sell-off in Chinese shares and pump them back up, the unexpectedly big drop yesterday, on virtually no discernible bad news, could signal a serious crash ahead.
U.S. and international investors need to understand what's going on in China and position themselves to profit on a full-blown market crash there that could ignite global contagion…
The Sky Really Did Look Like the Limit
Chinese stocks were on a tear up to June 12, 2015. The Shanghai Composite soared 51% from the beginning of 2015 through June. It rose 134% in the past year. That meteoric rise was dwarfed by appreciation in the smaller Shenzhen index, which was up 173% over the past year, with a whopping 109% rise since the start of this year.
In spite of government cheerleading all the way up, spooked investors, for no good reason other than perhaps their own fear of heights and the economy's slowing growth trajectory, began selling in mid-June.
And sell they did…
The Shanghai Composite, the big Chinese benchmark index where China's biggest companies are listed, fell 32% in three weeks. From the market's peak on June 12 to the early July lows, companies listed across China's stock markets lost close to $4 trillion in value.
What looked like an uncontrollable freefall had to be met with government intervention; there was no other way to stem mounting losses caused by a negative feedback loop that happens when margin calls force market sell orders that push stocks down more, triggering further margin calls.
Master Manipulators Inflated Stocks… Then Had to Come to the Rescue
Frightened government officials and market regulators rushed to shore up the rapidly eroding banks of what had become the country's focus – soaring markets.
Government cheerleading from politicos, market regulators, and the Communist Party-controlled China Daily newspaper advocated stock ownership and touted the Shanghai Composite's rise above 4,000 as just the beginning of the bull market.
The cheerleading efforts were more than effective. Since the beginning of 2015, the China Securities Depository & Clearing Co. estimated new investors were opening up an average of 170,000 brokerage accounts a week.
The bad news turned out to be the new investors were mostly woefully undereducated speculators with no practical knowledge about stock trading or investing and a frighteningly large contingent of corporate executives who jumped into the markets with company capital, believing they could make more money riding the bull market than manufacturing goods in their slowing domestic economy and for a flat-lining global market.
If that wasn't bad enough, almost all the "new" investors employed huge amounts of leverage, buying stocks on margin.
By April 10, 2015, a month before the markets turned sour, margin reached a record $264 billion. But, again, that's not the worst of it. That margin calculation came from the China Securities Finance Corp., a government-controlled entity, under the watchful eye of China's market regulatory body, the China Securities Depository & Clearing Co.
No one has any idea how much other margin was extended to speculators through China's notorious shadow banking channels. Some analysts have estimated shadow margin lenders, charging above-market rates on loans backed by the value of inflated securities, could be equal to or higher than official margin loan calculations.
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.