Thursday, December 06, 2012

Lessons from the Sad Experience of China’s Retail Stock Market Investors

Sovereign Man’s Tim Staermose thinks that China’s glum retail sentiment on the stock market appears as a bullish contrarian signal, [bold mine]
Since 2009, the benchmarkShanghai Stock Exchange index has been in a deep funk.  Last week, in fact, the index hit 4-year lows and dipped below the psychological 2,000 level.

Further, a recent survey of 8,438 Chinese households published by China’s Southwestern University of Finance and Economics found that 77% of those who had invested in Chinese stocks lost money.

This is huge. Chinese retail investors account for around 80% of the transactions on domestic exchanges. Famous for being active traders with investment behavior bordering on gambling, Chinese retail investors are now completely disillusioned with the market.

According to JP Morgan, as of the end of October 2012, 44% of all Chinese stock trading accounts had been dormant (i.e. without activity) for at least a year.  At the end of 2007, the comparable number was just 2%… an enormous difference.

These are the sorts of data points that contrarians love. Whenever the retail crowd runs loses interest in investing, it generally suggests that the bottom is in. Today, China fits that bill.
There are two aspects to draw from the above account

One: sentiment of retail investors as market indicator

Chart from

China’s case looks like the classic depiction of the popular Wall Street axiom, “Bears make money, bulls make money but pigs get slaughtered”

It’s a showcase of how artificial booms seduces the gullible and vulnerable.

It essentially starts with the adage “In a bullmarket, everyone’s a genius.”

Hardly anyone realizes that in an inflationary boom, whatever analytical method one adapts gets to be validated via ascending prices, usually manifested through the rising tide lifts all boat effect.

Easy money lures the public to engage in reckless behavior. The string of initial successes would embolden neophytes to take on more aggressive risk taking. The public will even expand or increase their speculative exposures by engaging in margin trades with the hope of snaring greater profits. Emotions will dominate trading activities.

Mainstream narratives will rationalize the public’s intensifying derring do actions, even if they have little to do with reality

As I previously wrote, (bold original)
And the rising tide compels people to make various attributions to market actions, such as economic growth or earnings or mergers and acquisitions, no matter how loosely correlated they are or how little relevance they are with the genuine market drivers. Most of this account for as popular dogmatic fables or widely held superstitions as evidences does not support the causality nexus from such premises.
And most people will fall for the self-serving (attribution) bias believing that they have attained success through personal skills and that failures are brought about by misfortune or external forces.

All this leads to the fatalistic “overconfidence”.

Worst, little is understood of the real factors driving boom-bust episodes. 

During the boom phase, rising prices will be seen as perpetual dynamic or even an entitlement. And any fall in prices will be tainted with political color “insider trading, price manipulation and etc…”

And when the stage has been reached where you have unintelligent money via housemaids, gardeners, farmers pouring into stocks, such should be seen as warning signs

Again in my article cautioning the idea that household helpers should be enticed to speculate in the stock market, I wrote,
During the acme of the bubble cycle in China in 2008, the onrush of retail punters into stocks, which included housemaids, signified the peak of frenzied activities.

As Shujie Yao Dan Luo of The University of Nottingham wrote in their recent study, (emphasis added)

``Most of these investors, which included farmers, cleaners, taxi drivers and house maids, knew little about stock markets and how share prices were determined. Many of these people started investing in the stock markets when prices had already risen rapidly to peak levels, just before the market bubble burst. The participation of these ‘envious’ investors artificially prolonged the bullish market and created a much larger market bubble than would have occurred had they not become involved.”

In short, retail investors GOT SINGED and were left HOLDING THE EMPTY BAG. They accounted for as the FOOL in the Greater Fool Theory.
I have seen this personally before.

In the Philippine Phisix bear market trough of 2002, I spoke with several retail accounts assigned to me by my principal, to persuade them to take advantage of what I believed as the market’s major inflection point

Then the typical response to my suggestion has been one of embitterment. Yet I wasn’t speaking to lowly accounts but to the upper middle and to the wealthy accounts.

I even recalled being cussed at by a disenchanted retail account. The person said that the stock market was a fraud and had been manipulated and that my being part of it means I am part of the cabal.

Well, the market began to recover in March 2003 or about less than a year after I made my pitch. The rest is history


Thus, I am in sympathy with contrarian view that extremely negative sentiment or depression by retail investors can be construed as signs of the market’s bottom.

Next, has China’s Shanghai index bottomed?

This really depends if there are still significant degree of real savings from domestic wealth generators from which the Chinese government's reflationary policies will draw from.

As Austrian economist Dr. Frank Shostak explains,
The only way fiscal and monetary stimulus could "work" is if the flow of real savings (i.e., real funding) is large enough to support (i.e., fund) government activities and activities that sprang up on the back of loose-monetary policy while still permitting a positive rate of growth in the activities of real-wealth generators. (Note that the overall increase in real economic activity is in this case erroneously attributed to the loose fiscal and monetary policies.)

If however the flow of real savings is falling, then, regardless of any increase in government outlays and monetary pumping overall, real economic activity cannot be revived. In this case, the more the government spends and the more the central bank pumps, the more will be taken from wealth generators — thereby weakening any prospects for a recovery.
As explained last night, China’s Shanghai Index posted the biggest gains in 3 months of 2.9% yesterday. This could highlight a dead cat’s bounce (from oversold conditions), or might be suggestive of an inflection on the back of recent easing policies. I would add to this the depressed retail sentiment.

Today, the Shanghai index has been little change.

No comments: