Saturday, April 19, 2008

Universal Investing Mistakes

Via the WSJ:

The sharp decline in Chinese stocks is approaching a milestone: With a 4%drop Friday, the market has fallen by nearly half since its peak last fall. The decline has wiped out nearly $2.5 trillion of wealth and is testing the government's apparent resolve to let the market find equilibrium on its own.

The plunge has slashed the savings of millions of Chinese investors who jumped into the market as it rose six-fold in two years. It is crimping expansion in the country's nascent financial sector and may put a squeeze in corporate coffers. But so far, it has not slowed the world's fastest-growing major economy.

I stayed away from Chinese stocks through most of the run up so I haven't suffered as it has come back to earth. Now, I'm starting to get interested. Are Jim Rogers and Marc Faber right? Both of these very smart investors have decamped to Asia on the belief that the investing world's center of gravity is shifting away from the US. If they are right and Asia is the place to be, then this Chinese correction may be a great opportunity. The Chinese economy is still expanding rapidly even as the Chinese government attempts to apply the brakes; growth was reported last week at 10.6% for the first quarter. Inflation is higher than one would want, but with the Yuan tied to the dollar, that is more our fault than theirs. And they do seem to be allowing the Yuan to appreciate at a somewhat quicker pace recently. I tend to think that Rogers and Faber are right and that Asian stocks will offer greater growth than the developed markets, but with a much higher degree of volatility.

One thing that doesn't change though no matter what market you are considering. Investor/traders are all the same; they make the same mistakes no matter their nationality. Chinese investors are sitting on some pretty steep losses right now and they sound like any investor anywhere in the middle of a bear market:

Investor psychology, however, has taken a big hit. Last August, Qiu Jiaxin, a 27-year-old school administrator, bought 100,000 yuan, or about $14,000, of Shanghai-listed Western Mining Co. after its stock more than doubled to about 60 yuan a share. Looking at the global resources boom, "we thought it would go up again," says Mr. Qiu.

It didn't. The stock now trades at 20.85 yuan, and Mr. Qiu has delayed a home renovation and pushed plans for his wedding to 2009. The Shanghai resident isn't selling just yet. "It is not a small pool of money. It is a big loss to us," he says. "If we don't sell, it is only a paper loss."

That last sentence is classic. It doesn't matter whether you sell or not; you're sitting on a loser Mr. Qiu! This guy doesn't qualify as an investor or a trader. A good investor would have had a better reason for buying than "we thought it would go up again". A trader wouldn't have ridden this dog all the way down. Ever hear of a stop loss Mr. Qiu?

This is classic behavior too:

Small investor Guan Jun plans to save $3,000 by taking this year's holiday in China's Yunnan Province instead of the Maldives. He bought China Petroleum & Chemical Corp. shares at 25 yuan, and they are now trading closer to 10.43 yuan. "It should be a right time [to sell] when it rebounds," he says.

Guan Jun is future resistance at 25. He's down so much he's just looking to get even so when the stock gets back to where he bought, he'll be a seller. If a lot of other investors bought the stock at that price, the stock will stall at that price until all the sellers are satisfied. And then the stock will go higher to maximize their frustration. In an alternative scenario, the stock keeps going down and Guan Jun's nest egg continues to deteriorate. Guan Jun broke the cardinal rules of stock trading. You must have a sound rationale for owning a stock and you must have a sell discipline. If you follow those rules, you have a fighting chance in the market; if you don't, you are doomed to failure.

The article is referring to mainland shares that non Chinese can't buy so you can't participate directly in this market:

Most U.S. investors are unlikely to feel much direct impact from China's stock fall, because the shares traded in Shanghai and Shenzhen are off-limits to the vast majority of foreigners. While a few U.S. funds have received permission to invest in these stocks, "it's very speculative, and the quality of companies is not comparable to the Chinese companies listed in Hong Kong," says Richard Gao, portfolio manager of the $1.5 billion Matthews China Fund in San Francisco.

However, some international funds are feeling pain because the plunge in Shanghai-listed shares has been matched by similarly steep declines in shares of Chinese companies listed in Hong Kong, New York and elsewhere. The iShares FTSE/Xinhua China 25 Index Fund, an exchange-traded fund listed on the New York Stock Exchange, is off by 33% from its peak last fall. The Matthews China Fund is off by 32% from its peak.

The Hong Kong shares are cheaper than their mainland counterparts:

The Shangahi index remains triple its level at the June 2005 trough, but the market no longer looks as out of sync with global values as it once did. The prices of class-A shares, mainly for domestic investors, of Chinese companies listed on domestic exchanges are now 40% more expensive on average than the same shares of those companies listed on the Hong Kong exchange called H shares. That's down from a peak last August of 54%, according to ABN-Amro analysts.

That seems like a huge gap that will have to be closed someday. Obviously, it can be closed in two ways; A shares can fall or H shares can rise or more likely some of both. Until there is a way to arbitrage the different prices though, A shares will likely continue to trade at a premium. The easiest way to participate in the H shares is through Barclay's iShares FTSE/Xinhua ETF (symbol FXI)I'll be looking for an entry point.

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