China's Fear of the Bear Is Creating a Monster
As is well known now, China's stock market has corrected pretty substantially over the past week. What should be stated up front is that unless the Chinese as a population have decided to wholly reverse their embrace of hard work and market forces, investors should relax. They should because as any visit to China reveals in exciting, shimmering-skyscraper fashion, the people there are wildly productive. Whatever the present economic uncertainty, China's going to be fine economically over the long-term, and by extension investors will be fine too. "Secular stagnation" is a myth, and it will particularly be revealed as a myth in a country like China full of people in a hurry to get rich.
Thinking about the correction itself, what a shame that government officials have attempted to blunt its impact. Figure corrections are healthy. They are because markets always and everywhere price in the future. Assuming a stock plunge in response to policy changes inimical to growth, the correction is the signaling device telling government to reverse course. Plunges indicate what investors feel government should undo or moderate so that future growth isn't compromised.
We see this in individual stock prices all the time. When they decline it's a market message from investors that company management must change its ways in order to please investors. This is good. Along these lines, the credit default swaps (CDSs) that needlessly terrified certain members of the media in 2008-2009 were in fact very worthy market creations. They were and are one way that investors express their optimism or skepticism about the ability of a company to pay off its debt. Whatever adds to investor knowledge is a good thing. Informed markets redound to economic growth for them limiting the waste of always precious capital.
That's why government actions that led to stock-market shutdowns in China last week were so unfortunate, as were "circuit breakers" that occasionally forced the halt of trading. When stocks are correcting it's essential that governments stay out of the way. To understand why, we can't forget that a bearish seller can only express extreme pessimism insofar as bullish buyers are able to express a similar amount of optimism. In shutting down markets, Chinese officials blocked the entrance of optimistic buyers willing to match the pessimism of bears.
And in depriving markets of true pricing, these same actions almost as a rule pushed bulls to the sidelines. Figure no bull is going to wade into uncertain markets unless prices fully reflect the pessimism of bears.
It also can't be forgotten that liquidity is important. If a market is seen as illiquid such that it's tough for investors to exit, this must reflect itself in share pricing. So with market shutdowns and "circuit breakers" creating uncertainty about how easy it would be for investors to exit shares, the latter truth necessarily forced a re-pricing of shares in a downward direction. The price of anything will necessarily be lower if the simple sale of it is understood to be fraught with uncertainty. Chinese officials fear a bear that would in many ways stare at them in the mirror if they were to look at one.
All of which brings up back to individual companies. That's all a stock market is. It's just a place (or increasingly electronic concept sans walls) where investors "vote" on the value of various companies' future earnings. Market "corrections" are essential with the future in mind simply because the fortunes of companies change all the time.
The best way to consider the above is through economic recessions. When left alone they tend to be followed by major economic rebounds. Of course they do. The recession is the cure signaling a looming expansion. Recessions indicate the cleansing of labor misuses, bad investments, and lousy companies holding the economy back. When allowed to run their course the fixes are made that set the stage for the rebound.
Market corrections should be viewed in the same way as recessions. They're yet another way for investors to cleanse the economy by virtue of investors depriving bad companies of scarce capital so that good ones can access it more readily. Looked at in American terms, absent the twins that are corrections and recessions, the commercial landscape in the U.S. would still include Borders, Blockbuster Video, and Webvan. Thanks to market and economic forces, none of the three are presently hogging always limited resources.
Applied to China, a market correction left alone would be the sign of a coming market bonanza for it indicating a reorientation of always limited capital into the companies that are best positioned to use it wisely. Without bear markets there can't be bull markets.
So while this writer wholly dismisses the notion that the Fed's QE actually boosted the U.S. stock market, assuming it did wise minds can only say it did so at the expense of much more vibrant U.S. markets in the present. We know this because if it artificially propped up otherwise weak U.S. companies, it did so largely at the expense of much more vibrant replacements. Can anyone say with a straight face that the U.S. economy would be healthier had Radio Shack not gone bankrupt?
Back to China, the market correction if left alone will be the cure. Either it will force changes in government policy, or a redistribution of crucial capital by market disciplined investors from bad companies to good ones. Chinese stock markets that can't correct downward can't soar upward either. China's fear of the "bear" is creating a needlessly grouchy one.
