Get Out of China While You Still Can

By Morgan Housel

As you've probably heard by now, today marks the 20th anniversary of the stock market crash of 1987, which yanked down the Dow Jones Industrial Average by 22% in a single day. I can hardly think of a better way to commemorate one of the most famous stories of irrational expectations that ended in calamity than to discuss the world's frothiest, most overheated, and biggest waiting-for-trouble market: China.

The financial world is no stranger to bubbles. As we've seen with the stock market crash of 1929, the Nifty 50 in the early 1970s, Taiwan and Japan in the 1980s, the Nasdaq dot-com hoopla in 2000, and the real estate mania over the past seven years, there's rarely a shortage of stupidity somewhere in the markets.

One belief that tends to characterize these bubbles is that "it's different this time." People justified the incredible surge in the Japanese Nikkei average because they knew electronics would change the way our world functioned. They justified the Nasdaq boom by saying the Internet would forever change the way people do business. In both cases, those people were right about the effects on our lives -- but that didn't justify the massive speculation that dominated the market.

Sure, the Chinese economy has a lot going for it right now. For the first time since economic restructuring began in the 1970s, growth is being fueled by the citizens -- not the Communist government. Combine that with low interest rates, an increase in property values, growing corporate profits, and a sky-high personal savings rate ... and, heck, maybe it is different this time, right?

Keep dreaming. Just as the day after Christmas used to depress me beyond belief, all excessively good things must come to an end.


Regardless of a slew of factors stacked in its favor, China is no exception to the rule that speculation always leads to a fall. Here are some of the factors that make the Chinese stock market look more like a Las Vegas casino floor than an attractive place for your money.

The big guys have left the building
Big-timers like Li Ka-shing -- whom some regard as the Warren Buffett of Asia -- along with Chinese central bank governor Zhou Xiaochuan and Alan Greenspan all share a strong sense of pessimism about the Chinese market. Unlike the U.S. stock market, which is dominated by hedge funds and mutual funds (whose managers, in theory, should know what they're doing), 70% of Chinese market activity comes from regular people. One-sixth of all Chinese individual brokerage accounts have been opened in the past year; the fact that the indices have more than doubled in value during the same period should come as no surprise.

Eastday, a Chinese government-run website, announced in April that 10% of all the maids in Shanghai have resigned because day-trading stocks became more lucrative than traditional work. Here's a quick rule of thumb to remember in investing: When everybody and his or her mother is rushing to get in, it's time to pack your bags and head for the exits.

Rationality: a thing of the past
So much speculation has entered the Chinese market that some traders have opted to focus on superstition. Some are picking lucky ticker symbols that include the number 8, which in Chinese is a homonym for good luck. At this point, Sylvia Browne is starting to look rational.

The Chinese market has all but abandoned the idea of investing in companies. It's now completely based around the fear of not getting aboard before the train takes off. As Buffett said, "Like most trends, at the beginning it's driven by fundamentals. At some point, speculation takes over. What the wise man does in the beginning, the fool does in the end."

As jittery as a hummingbird on Red Bull
And talk about neurotic. All it took in February was a tax on trading to send shares down more than 9%. Even the slightest hint of bad news could send shares falling faster than you can panic sell. I bet that'll make you feel different about taking a bathroom break.

Will China go any higher? It easily could. But that certainly doesn't mean you should hope to pick the top. Bubbles burst much more quickly than they form, and it could be far too late before you realize how much trouble you're in. Don't kick yourself for watching others make money by irrational means. Stick to sensible investing, and you'll always be left with the last laugh.

And if speculation is your thing, go to Las Vegas. You're odds of winning are better, and you'll eat for free.

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