China Syndrome

What's there to say on a day like today?

We hear there's this thing called a stock market, and that sometimes stocks go down.

As unbelievable as this may sound -- after a period where many major markets have been rising for years without the customary hiccups -- the reaction to the Shanghai market's 8% dump confirms a simple truth. The more things change, the more they stay the same.

International stocks of all types are taking a pounding today, precipitated by the 8.8% drop in the Shanghai market. The ripple effects have spread to markets across the world, with the result that just about anything and everything is looking red today, especially if it's foreign. Chinese stocks are taking it worst, with issues like Brilliance China (NYSE: CBA  ) and Trina Solar (NYSE: TSL  ) down 12% or more.

Foreign banks, as you might expect, are also taking a drubbing. In locales as diverse as South Korea, Brazil, Chile, and Greece, multiple banks are down 5% or more: Kookmin Bank (NYSE: KB  ) in Korea dropped 5.7%, Brazil's Unibanco (NYSE: UBB  ) shed 5%, and National Bank of Greece (NYSE: NBG  ) lost 4.5%. As the ripple effects of any financial crisis are generally felt early by banks, this isn't a huge surprise. (Most important for us, the fall is quickly bringing a number of well-run banks back to attractive prices.)

Learning from losses
Here's a bigger question to ponder: Does this drop in the Chinese market really matter? A look back suggests it's long overdue. The benchmark Shanghai index soared 130% in 2006 and hit another record just the day before the fall. The Shanghai Stock Exchange has grown to a market capitalization of $1.5 trillion, making it, quite suddenly, the world's eighth largest (just trailing the Hong Kong Stock Exchange at $1.7 trillion). Step off the ledge, readjust the rear-view mirror, and you might just say the real story here isn't the drop, but the preceding gain. Was it warranted? Why did it happen in the first place? Was it a natural result of China's robust economic growth, or a symptom of enthusiasm -- maybe excessive enthusiasm -- for the world's most talked-about economy?

Back in 2005, the Chinese market was lagging the S&P 500 by a pretty wide margin. We read story after story about a new generation of young investors calling for government regulation to protect them from losses. These were young folks who already felt burned by speculations that had gone sour during only a 20% downturn. Six months ago, the tone changed. Now it was reports of lines forming outside brokerage offices and day-trading centers, or -- as Bill mentioned on our Motley Fool Global Gains boards -- of people mortgaging their homes to put money into the market. Take a look at this chart, and you'll be able to place those themes quite easily on the timeline. "It's not fair" always corresponds to the drops, and as for "What could go wrong?" -- well, you know where that figures in ... yesterday.

No surprises here
A little more than a month ago, Bill penned an article called "The Coming Emerging Markets Disaster," which foretold of today's quick collapse. It attracted, perhaps unsurprisingly, some weapons-grade responses from people who believed that we were trying to knock these markets down (as if we could), and/or that we were wrong about the power of the growth engine in China and other countries. In particular, people who owned shares of American Oriental Bioengineering (NYSE: AOB  ) , a spectacular little Chinese pharmaceutical company, were up in arms at the suggestion that the company's shares could be dragged down if the Chinese market suddenly weakened. Lo and behold, that's precisely what's happening.

We at Global Gains aren't soothsayers -- we didn't go home yesterday saying that things were going to go to pot overnight. But we do pay a great deal of attention to the excesses that come with rank speculation. The Chinese market, which doubled in 2006, attracted a great deal of just this kind of heedless greed. Given this, a day like today was a virtual certainty.

Foolish conclusion
Unfortunately, in markets, there's always plenty that can go wrong. And so far as we can tell, nothing really went wrong in China, aside from the fact that people were interested in "taking profits" (to quote a variety of pundits who also can't seem to find a reason for the drop). It bears remembering that the drop in the Chinese market has wiped away all of the gains generated since November -- November 2006, that is. These sorts of days are good reminders that the stock market sometimes becomes disjointed (with economic realities for the underlying companies), and that equilibrium will always be restored.

Sometimes there is no reason to trigger the readjustment, and that's a good reason for caution. But it's no reason to sour on China, international investing, or stocks in general. What you see now in China is the response to some real speculative excess. What you see regionally -- with companies like Korean financial powerhouse Woori Finance (NYSE: WF  ) and Global Gains-recommended Taiwanese online gaming company GigaMedia (Nasdaq: GIGM  ) getting hit -- speaks to the rising level of influence China has on the region. That the Nasdaq and NYSE opened down more than 2% speaks to just how important and integrated China is to the world economy.

And to us, that's a good thing.

Come and join Bill, Seth, and Nate at Global Gains as they pick through the world's great companies. A 30-day guest pass is yours for the asking. At the time of publication, Seth Jayson had no positions in any company mentioned here. Bill Mann had a position in American Oriental Bioengineering. Nate Parmelee had no positions in any company mentioned. GigaMedia is a Global Gains recommendation. The Fool's disclosure policy is fully integrated.


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