China and the Stock Market

China! Aggghhhh! Everyone panic. (And China panic again…)

The Chinese stock marketing is crashing, and it’s making everyone nervous. As always, long-term investors with diversified portfolios need do nothing other than sit back and watch. I, for one, like following along the headlines. You know, the ones that swing violently from doom, to fine, and back again.

What Is Happening In China?

Once upon a time, China was a communist country without much of an economy to speak of. Then, the government decided it wanted to be a big world economy, and in China, what the government wants, the government gets. The Chinese government devoted billions and billions of dollars to building up new cities filled with factories, and then spent even more money subsidizing those endeavors until, everything was made in China. With a new power economy, China also decided to get the other “regular” economy things like banks, lending and even a stock market.

Fast forward a few years, and the Chinese stock market has been roaring along. Then, earlier this summer, the Chinese stock market started to drop. The government stepped in and put a stop to it. Unfortunately, real stock markets eventually end up doing what they want (need?) to do and all such interference does is delay the inevitable.

Which brings us to now. On Monday, the U.S. Stock Market, as measured by the Dow Jones Industrial Average fell, at one time during the day, over 1,000 points. It closed down 588 points for the day. This fall was attributed in large part to the Chinese stock market losing 8.5 percent the day before. (Thanks to time zones, Monday in China occurs overnight on Sunday here in America. In other words, the U.S. stock market already knows what happened in China when it opens. This is particularly pronounced on Mondays, because both markets have been closed for the weekend.)

The following day (overnight from Monday to Tuesday in the U.S.), the Chinese markets, as measured by the Shanghai Composite Index fell 7.5 percent. At first, it seemed like the U.S. markets might rally up. After all, the China thing isn’t THAT big of deal for the U.S.  At one point, on Tuesday, the Dow was actually up, hitting a high of 16,313, around mid-day. But, then after 3:00 pm, things rolled over and end up down almost 205 points at 15,666.

What happened?

Again, the Chinese markets trade overnight when the U.S. markets are closed. There are people out there who aren’t interested in holding their investments overnight, just in case things get even worse in China while everyone over here is sleeping. Better to be in cash, than unable to get out if the China meltdown gets worse, the thinking goes.

What’s The Big Deal?

As you read the dramatic headlines, you may think this is the end. The reality though is a bit different.

First, analysts have been saying for quite a while now that the Chinese stock market was in a bubble. Those same analysts have been noting for even longer that the U.S. stock market has gone a very long time without a correction (technically defined as a drop of 10%). In fact, if you read this article from this very same finance blog earlier this year, you’ll see that I mention that some sort of blow up in either Greece or China would probably be the thing that finally pushed the U.S. markets over into the long called for correction. (Do I get a cookie?)

In other words, according to everyone watching the markets, both were due for a drop of some sort. In fact, the good news is that we can stop hearing about the no correction thing now. That one drop was 10% all at once, so the correction clock starts all over now.

You’ve heard that these stock market plunges have wiped out all the gains from this year. That’s true, but the real question is, if those gains were already on shaky ground, then were they ever legitimate gains? And, if not, aren’t these drops just putting the prices back where they actually should be?

In other words, is the stock market plummeting, or is it just fixing the unrealistic move up from earlier this year?

Whatever the answer, here is a quick reality check. This is a 5-year chart of the Dow average:

dow 5-year chart

Stock prices are down alright, but your 401k is probably still higher than it was a year or two ago. Remember, unless you are day-trading, these price swings are not relevant.

The Chinese index chart is even crazier. You remember that 8% drop, followed by a 7% drop? Huge, right?

Only here’s the thing. While those drops took out the Year to Date gains, they still still weren’t enough to even take out the bottom of a one-year chart.

The reality is that the mountain on that stock chart from February to June probably wasn’t based on legitimate fundamentals in the first place. This quick fall, probably puts things back where they should have been all along. What happens next will determine whether the Chinese economy hits a rough patch, or this is just a bunch of noise for a short period of time. Either way, everyone knows that the current Chinese economy is based on unstable ground. It will have to sort itself out sooner or later.

china-index 12 months

When looking at their “losses”, people tend to count from the top. In other words, today, people are talking about how much they “lost” from the absolute peak rather than from where they actually invested. This is the kind of thinking that leads to fear-based selling. The reality is that the peak was a mistake, that’s what makes it a peak. You didn’t lose money from the peak, you should have never had the peak in the first place.

When you look at your portfolio, don’t compare to the top amount you ever had, compare to what you invested, or to what you had last year, or even the year before. The 5-year chart is still substantially up, and that is how the markets work. Your investment goes up, and it goes down, but if you don’t panic, it will go back up again (and it will go back down again).

Sit tight America. The ride will be bumpy, but the reality is that the U.S. economy is looking up, and has been for a while. In the end, that’s what really decides where the Dow goes, not what’s going on in China.

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