They don't know when, exactly, but millions of investors are worried they're about to get wiped out. For you, this is good news. If their worries are on target, we're about to be able to buy the world's fastest-growing stocks for cheap.
Before I get to the whos, whys, and wheres, though, let me tell you whom we have to thank ...
Here comes the cabal
Although owners of heavily shorted stocks such asCharter Communications (Nasdaq: CHTR ) , RF Micro Devices (Nasdaq: RFMD ) , and Dendreon (Nasdaq: DNDN ) may disagree with me, short-sellers are crucial to healthy markets.
By making the case for stocks to go down, short-sellers make the market more efficient. Shorts temper excessive optimism, helping us all avoid the protracted painful corrections that are its consequence.
Where shorts don't tread
Optimism, however, has been the defining characteristic of Chinese markets since the beginning of 2006. Chinese stocks gained 130% that year, and another 97% in 2007. As a result, money moved into the Chinese markets at a remarkable clip, and stories abounded about Chinese housewives, cab drivers, and fishmongers speculating in the market.
And there was nothing to curb their optimism.
See, you can't short stocks in China. Without investors scouring the market for weaknesses, those same housewives, cab drivers, and fishmongers have been treated to nothing but good news. That's made them overconfident, overzealous, and now overexposed to an unquestionably richly valued basket of stocks.
It won't be that way for long ...
But change is coming. China's Security Regulatory Commission recently announced that it is set to launch stock index futures contracts. Finally, investors will be able to bet on the decline of the Chinese market, therefore gaining incentive to closely scrutinize whether Chinese stocks deserve to be the world's most expensive.
This is not a perfect solution. Because investors can only bet against a basket of China's 300 largest stocks, company-specific research will fall short. You would have lost money, for example, shorting the S&P 500 in 2007 (when it returned more than 5%), even if you had been spot-on in your assessment that big financials and homebuilders such as E*Trade (Nasdaq: ETFC ) , Washington Mutual (NYSE: WM ) , Pulte Homes (NYSE: PHM ) , and Centex (NYSE: CTX ) would all decline (which they did).
The Chinese government's move is a step in the right direction, though ... and it has many worried that novice Chinese investors will start pulling money from the market at the first hint of a downturn. The implementation timeline, however, seems to have been delayed due to the recent volatility in the Chinese market. Its overseers know that investors are already spooked and seem to be hesitating about introducing shorting, which could spook them even more.
Still, this is a development worth keeping an eye on.
Get ready to buy
The government is right to be wary. You don't need a great memory to recall that the Chinese market dropped nearly 7% in a day last May, when the government simply raised taxes on trading. The reaction to new negative sentiment will likely be far worse.
That's why you should be licking your chops.
China's rapid economic growth will be the global economic story of the next 10 to 20 years. The opportunities are huge, and the country is growing richer by the day. In fact, our Motley Fool Global Gains international investing team recently returned from a research trip to China, where we were almost universally impressed by the companies we met with and the growth trajectories they displayed.
That does not mean, however, that we'd be willing to pay any price to own them.
The big bounce
We're crossing our fingers at Global Gains that the introduction of shorting to China will cause a widespread sell-off. Buying quality companies when others are indiscriminately selling is precisely the formula for making a lot of money over the long run.
At Global Gains, we've also already recommended a couple of Chinese companies that we think are compelling values and we're ready to double down at the first sign of weakness. We're waiting patiently to back up the truck to our wish list.
If you'd like to learn more about the companies we're recommending, and the companies that make our wish list, click here to try Global Gains free for 30 days. There is no obligation to subscribe.
This article was first published Aug. 20, 2007. It has been updated.