They don't know when, exactly, but millions of investors believe things could get a whole lot worse. 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 even cheaper.
Before I get to the whos, whys, and wheres, though, let me tell you who we have to thank.
Here comes the cabal
Although owners of heavily shorted stocks such as Sirius XM
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 was the defining characteristic of Chinese markets for a number of years. Chinese stocks gained 130% in 2006, and another 97% in 2007. Money has moved into the Chinese markets at a remarkable clip, and stories abounded about Chinese housewives, cab drivers, and fishmongers speculating in the market.
Of course, there was also nothing to stop them.
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 made them overconfident, overzealous, and in the end, overexposed to an unquestionably richly valued basket of stocks that is now correcting.
It won't be that way for long ...
For a while, change was coming. China's Security Regulatory Commission announced that it was set to launch stock index futures contracts. Finally, investors would 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 was 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 done poorly, for example, shorting the S&P 500 in 2007 (when it was up more than 5%), even if you had been spot-on in your assessment that big holdings like Pfizer
The Chinese government's move is a step in the right direction, though, but it’s now been put on hold. With the Chinese market already in a freefall, the government seems concerned that shorting would scare more Chinese investors out of the market.
Get ready to buy
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. This remains an immature and largely non-institutional market. The reaction to new negative sentiment will likely be far worse.
That's why you should be licking your chops.
Despite the weakness in its stock market recently, 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 additional panic. Buying quality companies when others are indiscriminately selling is precisely the formula for making a lot of money over the long run.
We've also already recommended a number of Chinese companies that we think are compelling values already, and we're ready to double down at signs of further 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 on August 20, 2007. It has been updated.
Tim Hanson does not own shares of any company mentioned. Pfizer is a Motley Fool Inside Value and Income Investor recommendation. Bank of America is an Income Investor pick. The Fool has a disclosure policy.
