Should We Worry About China?

End of Day Update:

The S&P500 traded in a tight range as Greek politicians debated the merits of an oppressive bailout and Janet Yellen testified in front of Congress. Given the magnitude the issues being discussed, it was a fairly benign day for the markets. The calm shows us most of the nervous and emotional selling already happened. The current crop of owners demonstrated a willingness to hold volatility and uncertain headlines over the last several weeks. This confidence keeps supply tight and props up prices.

While rate hikes and Grexits are old news, the situation in China is entirely different. Greece is tiny and most financial institutions long ago insulated themselves against a Greek default. And for the Fed’s rate hikes, going from 0% to 0.25% is trivial in comparison to the 3% historical average.

Problems in China, that is something our market is definitely not prepared to deal with. A recession in the world’s second largest economy would leave a gigantic hole in global growth. That is why traders fretted last week when the Chinese stock market plunged 40% from its recent highs. Luckily their stocks bounced sharply in recent days and this crisis fell off our front pages. That relief allowed our 60-point rebound.

NASDAQ historical chart

Should we worry about China? Should we ignore it? What should we do? Let history be our guide. Assume for a moment that China’s stock market is in the later stages of a NASDAQ, dot-com style bubble. If that’s the case, China’s selloff has a long way to go to match the NASDAQ’s 80% plunge. Clearly we should be panicked and sell everything, right?

Not so fast. Markets hate being predictable. When everyone claims the bubble is bursting, what is the market going to do? You guessed it, rally sharply. While it seemed like the dot-com bubble imploded overnight, the NASDAQ actually took three years to find a bottom. That collapse is many things, but fast is not one of them.

More interesting for us is how the NASDAQ plunged nearly 40% from the highs over a couple of weeks. That sounds eerily similar to China’s recent meltdown. So what happened next in the NASDAQ? It rallied 40% and held those early lows for another seven months! Just when everyone knew the bubble was bursting, the market found a bottom. If history were to repeat itself, then at least over the near-term, China found a bottom and we don’t need to worry about it…..for now. Six months from now is when we need to reevaluate, but in the meantime enjoy China’s reprieve.

Jani

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