What's there to say on a day like today? "We told you so," might be at the top of the list, but then, there have been plenty of people out there saying that the froth in China can't go on forever.
Let's start with the basics: There's this thing called a stock market, and 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 -- today's reaction to the Shanghai market's near-7% dump confirms a simple truth: The more things change, the more they stay the same.
What happened in China was typical of a command economy. The government drew a line in the sand. It tripled the rate of a trading tax and told the official news agency that its goal was to cool speculation in the markets. That led to the losses in Shanghai and elsewhere, and the minor ripple effect we're seeing here in the U.S. markets. Chinese-based companies as diverse as Suntech Power Holdings
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 it's up more than 50% so far this year. The Shanghai Stock Exchange has grown like a monster, some 300% over two years, vaulting it into the top 10 stock exchanges by market cap. Step off the ledge, readjust the rear-view mirror, and you might just say that 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. A year 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.
No surprises here
A few months ago, Bill penned an article called "The Coming Emerging Markets Disaster," which foretold of quick collapses. 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, 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 happened back in February, when the Shanghai market's 9% drop spurred a worldwide selloff, before everyone looked around and figured it was time to get back in. Since then, it's been more new records, and more and more news stories about gullible, average Chinese citizens putting all their money into a market they don't understand, and have little reason to trust.
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. In fact, now that the Chinese government looks like it understands the real nature of the problem, we're betting there will be more days exactly like this one, but even scarier.
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 now know that the Chinese government means business, just as it did when it acted to slow real-estate speculation a while back. These sorts of days are good reminders that the stock market sometimes becomes disjointed (from the economic realities of its underlying companies), and that equilibrium will always be restored. But, usually, the reaction vary wildly to the overly optimistic, then overly pessimistic, before the middle path is found.
Sometimes there's no reason to trigger a readjustment, and that's a good reason for caution. But it's also 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.
To us, that's a good thing. But only if we reflect on the reality of the situation, and react thoughtfully to circumstances that send everyone else screaming for the exits.
To do just that, I (Bill) depart for India, China, and Taiwan on June 2 to meet with company managers and seek out attractive investment opportunities in these fast-growing economies. You can get my updates and analysis live from the field by shooting me an email at BillTrip@Fool.com.
A version of this article was originally run in Feb. 2007. It has been updated.
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. Posco is an Income Investor recommendation. Suntech Power Holdings is a Rule Breakers pick. The Fool's disclosure policy is fully integrated.