Putting China in Perspective

If you follow the financial news, you know that China’s stock market is in the midst of a sharp slide. The benchmark Shanghai Stock Exchange Composite Index has fallen more than 23% in the nine weeks since June 12th of this year, closing down more than 30% some five weeks ago on July 8th.

What’s happening in China has the hallmarks of a bursting bubble. And it provides a textbook argument for why investors should plot out a course that’s independent of the hype-driven herd.

For years, Chinese investors have poured money into the country’s stock market based on the dubious notion that China can grow at more than 10% per year, indefinitely. And much of that investment capital has come in the form of cheap credit.

When investors are buying expensive assets with borrowed money, look out – you’re in bubble territory. The U.S. market is no stranger to bubbles, of course, from the Roaring 20’s to the late-1990s tech bubble to the more recent real estate craze.

Each case demonstrated the importance of a long-term investing plan based on diversification and discipline. The many Chinese retail investors who have chased hot stocks in recent years are now learning this painful lesson the hard way.

China’s leaders are scrambling to head off a market crash and, with the economy slowing, even a possible recession. Their moves include buying stocks directly and providing cheap loans that investors can use to buy stocks. To prop up the economy, the government has sharply devalued its currency. A weaker yuan makes the country’s exports more competitive in international markets.

Unfortunately, China’s currency devaluation is the latest in a long list of attempts to find a shortcut to growth. What the country really needs, economists agree, are solid free-market laws that will make its economy more efficient in the long run.

What does China’s situation mean for investors in the United States? Without a crystal ball, it’s impossible to say. China’s troubles may tip other countries into recession. But they might not. Those who claim to know are just guessing. By the way, investing based on guesswork can easily lead to market timing, and that’s a high-probability formula for increasing your chances to multiply costly investment mistakes.

As always, the key to successful long-term investing is to diversify, and hold good solid businesses – preferably those with rising dividend growth. As we’ve written in the past, those dividends have a compounding power that can help you with both your capital growth objective and provide you with some downside protection.

That being said, good buying opportunities can often be found in the wake of bursting bubbles. These should fit within your well-thought-out investment blueprint rather than being impulse buys, however.

You can be sure that many investors will make rash decisions in the weeks and months ahead based on headlines about China or other hot spots. The key is to remain calm when others are losing their heads. Remember, markets have always boomed and busted, and will continue to do so. Careful planning can help provide you with an investment portfolio more capable of navigating the ups and downs and carrying you to your goals.

If you need help developing a perspective that may help you invest more wisely, we may be able to help. At Intelligent Capitalworks, that’s just part of what we do.

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