My Favorite Plays to Ride the Chinese Government Sponsored Stock Market Bubble

COVID-19 is surging again in the South and West, with cities like Houston, Phoenix, and Tucson out of ICU beds or close to it.

Meanwhile, the economy is slowly recovering in fits and starts, with unemployment shrinking – but much slower than some analysts were expecting.

You wouldn’t know it from looking at the stock market, though. Fresh off a five-day winning streak, stocks consolidated on Tuesday.

And a crash like the one we saw in February and March is nowhere in sight. In fact, we’re in the fastest bull-market in U.S. history. Stories abound of stocks surging unbelievably fast. Some of them, like Hertz Global Holdings Inc. (HTZ), spiked only after they declared bankruptcy.

Part of the reason is the flood of millennials and generation Z-ers using the lockdowns to start trading stocks and options – who are joined by the sports betters who have no games to bet on – joining forces and using Robinhood and similar apps.

But this “disconnect” between the market and what’s happening out in the world isn’t just limited to the U.S.

In China, that reality gap is much, much wider.

In the short term, that’s very bullish, setting us up for a virtuous cycle of stocks pushing up one another.
But in the longer term, this is reason to start getting worried…

China Just Ordered a Bull Market

On Monday, China’s CSI 300 stock index surged by 5.7%, the biggest one-day gain since November 2015. The index rose 14% just over the last week.

Chinese markets, much like American ones, have been bullish all summer, but this extra jolt on Monday came from front-page editorial in the China Securities Journal.

It said China is attracting foreign capital, and the result will be a “healthy bull market” that will help the country “breed new opportunities in crisis, and break new ground in a changing world.”

On its own, an editorial talking up stock markets doesn’t mean much. But remember that in China, most media is run or overseen by the government. The China Securities Journal, for example, is completely government-run, so this editorial was widely taken as a sign that the government wants the bull market in Chinese stocks to continue and get even bigger.

And in China, the government usually gets what it wants.

So far, China’s government has issued some stimulus to get its economy going again, but nothing of the size or scope that we’ve seen in Europe and here in America.

This new bullish messaging from state media is making traders think the government has their back, and stimulus will come if needed.

Already, the amount of new brokerage accounts being opened is rising, daily stock market turnover is above $143 billion, and Chinese tech stocks are up 44% for the year.

The last time the Chinese government had media calling for a bull market, Chinese stocks doubled in six months.

And then crashed hard…

This Ended Very Poorly in 2015

In 2014 and 2015, Chinese media were similarly hyping up stocks, and individual investors in particular responded by opening accounts, trading on margin loans, and increasing daily stock turnover.

Unfortunately, that ended in tears. As interest rates and rules on margin loans started tightening, the Chinese stock market crashed. The pain was drawn out, too. From May to August, Chinese stock indexes dropped by 40%, and then fell again later in the year.

The repercussions saw even U.S. stock markets subdued for a bit. This year, it could spark another sell-off. American stock markets have shown they don’t care much about COVID-19 anymore, but any mention of new trade tensions with China still sends them down.

A Chinese stock crash could do the same.

Especially if all the “Robinhood traders” decide trading the fast-moving Chinese stocks is more exciting, and end up losing money there. After all, trading volumes here in America saw a huge upswing earlier this year, but have mostly fallen back to normal.

But with most sports and gambling still unavailable, chances are the fresh day-traders responsible for that decide China’s stock market is their next playground.

The good thing is that China isn’t in a bubble yet. Margin loans are up, but only at half of 2015’s levels. Stocks are surging, but much like in America, from a low starting point. Turnover is also rising, but still has room to grow before it gets to the dizzying heights from five years ago.

And hopefully Chinese authorities have learned their lesson and will keep a tight rein on margin trading.

More generally, there’s still a lot of legs left to this rally, in China and the U.S. both…

Still Plenty of Stimulus Left to Play With

So far in 2020, governments have created about as much money in stimulus as they did during the Financial Crisis 12 years ago.

But while those efforts were spread out over years, this time it’s all taken place in a matter of months.

That means there’s still plenty of stimulus money working its way through the system. And with bond yields and bank interest rates both practically at zero, stocks are the only place where money can grow.

So that’s where all that money will end up. But it hasn’t yet. The amount of money held in cash all over the world is actually higher today than it was before the pandemic.

That’s despite the fact that stock markets have surged since late March, and are up some 40%. Clearly, people are still sitting on the sidelines, waiting to get in.

In the U.S. alone, the saving rate in April jumped to 44%, up from an average of 7.9% last year.

But the longer people wait to invest that money, the more they’ll miss out. Meanwhile, every day is costing them as they get paid nothing in interest on their cash. With inflation rising and interest rates set to stay near zero for years, the cost of keeping money out of the stock market is only going to keep rising.

As that money trickles into stocks, it will keep the rally going in the short and medium term.

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Lots of China stocks are surging – especially today with Alibaba (BABA) up a whopping 8%. For the short term, I believe the China stock market is a buy. You can by quality names like the BAT stocks (Bidu, Alibaba and Tencent) on pullbacks. But my favorite China play remains JD.com (JD) – Alibaba’s main competitor in online commerce. It’s spiking today as well, but look for any pullback to add this to your short-to-intermediate term portfolio.

But it’s important to keep an eye out for signs of a stock bubble in China. If margin loans, for example, start getting near 2015 levels, it will be time to start lightening up. But until then, enjoy the government sponsored bull run.

Great trading, stay safe out there and God bless you,


D. R.

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