Tracking the Shanghai & Shenzhen markets: AFTY nears its August trough

I started following this around the beginning of June when Bill Gross made his "short of a lifetime" statements about the mainland Chinese stock exchanges in Shanghai and Shenzhen (not the ones listed in Hong Kong, and not the ones like Baidu or Alibaba that are listed in New York).

The index that most people are watching is the Shanghai Stock Exchange ( SSE), which dipped below 3,300 today to start the new year. It's trough for 2015 was on August 26 at 2,927.29.

However, I have preferred to follow AFTY, which is an ETF that tracks the FTSE/Xinhua A50 China Tracker index (see XIN9.L), which covers both Shanghai and Shenzhen, with Shenzhen being the more tech-related of the mainland stock exchanges. This is in part because AFTY is an ETF that also has a 3x-inverse ETF, YANG, that is the only good vehicle I knew of for ordinary retail investors to short the Chinese markets.

(Note that the Shenzhen Stock Exchange has a market cap of about $2.2 trillion USD, and the Shanghai Stock Exchange has a market cap of about $5.5 trillion USD. This is in comparison the Hong Kong Stock Exchange, with its market cap of about $3.94 trillion USD, NYSE, with its market cap of about $16.6 trillion USD.)

Anyway, I think we have seen some predictable swings (in character, even if the specific timing was inherently unpredictable) in AFTY, after it reached an intra-day high of 24.75 on June 8, just days after Bill Gross made his initial comments less than a week earlier. (This was coming right off his successful April statements about shorting the German bund.)

He was correct, and by July 8, AFTY had reached an intra-day low of 17.43, down 29.6% from the peak in just one month. That's when the Chinese government stepped in to halt the slide, and AFTY soon rose to 21.65 on July 10. But as with most government interventions in stock markets, a new slide started soon thereafter, with AFTY closing at 19.30 on August 10, before making the precipitous plunge to 13.00 in intra-day trading on August 24, 47.5% below the peak. The index then rose again to 17.48 on November 9 based on emergency government support measures, but now AFTY is again near its August trough, touching 13.01 for Monday, January 4, 2016.

To take a look at how and why the markets arrived at this point, a few articles from the financial media at key turning points in the narrative can be read:

June 3: " Gross’s Next Short Is This China Stock Index – But Not Yet" (Bloomberg)
July 8: " Gross Didn’t Execute China Short Trade That He Suggested" (Bloomberg)
July 27: " China losing control as stocks crash despite emergency measures" (London Telegraph)
August 28: " China's Stocks Cap Biggest Selloff Since 2008 on Rescue Doubts" (Bloomberg)

(Note that the index has since rebounded slightly in Asian trading for Tuesday, and currently stands at 13.13.)

Now there are government support packages that can stabilize a market crash and set stock indices on a lengthy upward trajectory, and there are government support packages that only delay the inevitable in painfully inefficient fashion. I would venture to say that this is an example of the latter phenomenon.

The classical approach to rescuing markets follows the advice of Walter Bagehot, to prevent collapse of large institutions. That can work, as it did in 1933 when FDR had a bank holiday and took the U.S. off the gold standard; and again in March 2009, when Bernanke & Geithner simultaneously signaled that rigid accounting rules for banks would be relaxed, and large institutions like Citigroup would not be taken over by the government.

Here with China, however, there is no classical lender of last resort action, nor any mass purchases of underlying assets, to be seen, which makes sense because this is a problem related to the capitalization of corporate profit, rather than a more direct problem with underlying loans or assets. In my opinion, it's somewhat akin to the Japanese zombie actions of the 1990s to keep dead things afloat.

Now it is true that having a communist government, the Chinese could recapitalize everything or inflate asset prices if they were totally committed to doing that. Nonetheless, they are not. If you read some of the articles to see what emergency measures the Chinese government instituted, you will see they fall into the categories of basically strong-arming market participants into holding onto crap and not selling anything--they may face rigged up corruption show trials if they don't comply.

During the non-rate-hike event on September 17, I made a few comments about how sensitive emerging markets like China were to FOMC decisions. Then at the close of October, I made a hypothesis that the S&P 500 would slump significantly by summer/fall of this year (although I never gathered the nerve to pull the trigger on actually purchasing any put options.)

As a new trough nears for AFTY, it'll be interesting to see how this affects the S&P 500. Some recent headlines from the past few days suggest that rocky days lie ahead for the entire Chinese economy.

Bloomberg: " U.S. Stocks Tumble After Selloff in China Renews Growth Concern"
Bloomberg: " China Hits Wrong 7% Target as Stocks Slump: Chart"
Yahoo: " Why Fed will backtrack on rates in 2016: Jim Grant" (Famous interest rate research publisher James Grant makes an argument similar to the ones I have made on this board in the past with B&tIJ when it comes to the dangers of the yo-yo trap of near-ZIRP monetary policy.)
Yahoo: " Two charts suggest the market rout in China is far from over" (The lovely Justine Underhill presents on how the Chinese index for large-caps, FXI, is showing a troubling pattern.)



EDIT: And here's an article that just appeared moments ago, although it is not yet completely written, " China Said to Intervene to Prop Up Stock Market After Slide."