Many investors in the Dow Jones Industrials (DJINDICES:^DJI) have grown frustrated with the market recently, as even new all-time record highs can't change the fact that the pace of gains has slowed and that the double-digit percentage average annual returns the index has enjoyed since 2009 aren't likely to last forever. By contrast, the Chinese stock market has boomed lately, with the Shanghai Composite more than doubling in less than a year's time. Even as some investors worry China has come too far too quickly, there are at least some signs that Chinese stocks are actually behaving better than their U.S. counterparts.
The value of corrections
Last night, the Shanghai Composite fell more than 6%, bringing out headlines that proclaimed the dangers of investing in Chinese stocks. In particular, market participants pointed to efforts by brokerage firms in China to make it more difficult for investors to borrow on margin in order to plow more money into the stock market. The fear is that as quickly as ordinary Chinese residents have gotten attracted to stocks, they could all try to leave in a mass rush when the tide turns, leading to potentially catastrophic volatility for markets in the world's second-largest economy.
It's true that China has become involved in the strength of stock markets throughout the Asia-Pacific region. The strength of the U.S. dollar has given Asian exporters a nearly unparalleled competitive advantage, and Japanese stocks have climbed to their best levels in 15 years as a result. Many worry about the sustainability of market moves that have resulted from policymakers' efforts to spur stimulus-driven growth.
Yet one of the best signs for investors is that corrections in China have been more frequent than those in the U.S. When the Shanghai Composite started taking off late last year, the index suffered not one but two 5% corrections in December alone. A deeper pullback of nearly 10% occurred in January and February, and last night's drop followed a similar one-day decline of over 4% earlier this month.
By contrast, U.S. stocks have shown few signs of volatility. The Dow experienced a similar decline in late January and early February, but it amounted to just 3% or so of the average's value. The Dow's 8% correction last October was one of its largest in years.
Is it China's turn?
Perhaps more importantly, China's stock market has taken years to start recovering from the fallout in the financial crisis, with an initial bounce in 2009 and early 2010 giving way to longer-term concerns about the sustainability of the nation's rapid economic growth. Now that conditions are improving, Chinese stocks are responding appropriately; even with the huge gains in the Shanghai Composite over the past year, the index is still more than 20% below its all-time high from 2007.
Many skeptics will point to the relative youth of China's stock market as evidence that it will eventually make the same mistakes that have previously plagued older stock markets. Yet the fact that movements in Chinese stocks reflect the risk involved in equity investing is a sign of a healthier market than the irrational complacency that U.S. investors have endured for years.