China’s stock market just went full retard

January 13, 2014
Punta Arenas, Chile

Well if this isn’t a screaming indicator, I don’t know what is.

China’s stock market has long been known as somewhat of a casino. Because of the nature of the Chinese writing system, stock symbols in China are numbers, not letters.

And as a rather superstitious lot, it’s long been common for many individual Chinese investors to pick stocks, not based on any fundamentals or prospect for future growth, but solely on whether the numbers in the stock symbol are ‘lucky’.

Just like playing the lottery, it’s really more gambling than investing.

Chinese stocks have been on a tear for the last six months. After spending the past several years bouncing around the bottom and suffering a crushing decline from continual all-time highs, Chinese stocks have soared 50% or better since last year.

And now that everything is nice and frothy once again, individual retail investors are back in record levels.

This was the case in 2005, 2006, and 2007 when Chinese stocks were practically doubling every year– towards the end of the boom, retail investors poured into the market betting their lucky numbers.

Then after the crash (and subsequent multi-year drought), all the retail investors got scared away. Nobody wanted anything to do with the stock market.

Now that the stock market is soaring once again, retail investors want back in.

The latest rage according to Bloomberg is individual investors buying ‘cheap’ shares.

In principle this is a solid investment strategy– buying shares of companies that are selling at a discount to their net asset value.

Except that’s not what Chinese investors mean by ‘cheap’.

Rather than looking at key valuation metrics, earnings multiples, book value multiples, or even the potential for long-term profitability… individual investors are just looking at share prices.

Their logic– if a share price is high, it’s expensive. If it’s low, it’s cheap.

In other words, with no further analysis whatsoever, they view a stock selling for 5 yuan as a much better investment than a stock selling for 50 yuan, simply because the 50 yuan share price is higher.

Of course, we know that nominal share prices are no indication of whether a company is cheap or expensive relative to other companies.

That’s why valuation metrics (like the familiar Price/Earnings ratio) and good ole’ fashioned analysis exist.

But what we’re seeing now in China is a record number of individuals flooding into the stock market. Bloomberg tells us that 80% of all equity transactions are from individual investors, many of whom are clearly inexperienced.

This is a huge warning sign. And frankly it would be hilarious if it weren’t so worrying… and sad that so many people are setting themselves up to lose.

Of course, it’s not just China. We’re seeing the same trends as stock markets across the world reach new highs: individual investors piling in at record rates.

It’s rather interesting that whenever something has been going up, people believe it’s a great investment and will continue to go up.

More realistically, all of this is a just another sign that there are serious problems in the financial system.

Markets everywhere are overheated. There’s too much hype. Too much expectation that everything will continue to go up in a straight line.

These are pretty classic signs of the top… and it begs an important question: would you rather miss out on another 20% gain, or skip out on a looming 50% loss?