Antibubble

After the last post, it’s only fitting to look around and see if we can find something that’s not in a bubble.  Or better yet, in an antibubble.

There is such a market. Chinese stocks.

The usual practice in reporting foreign stock market performance is to cite a local stock average in its local currency. Well known indices such as the Euro Stoxx and Japan Nikkei are examples. But it’s not a valid basis for an apples to apples comparison. The same units are required for that. I am not taller than you if you stand 72 inches in height and I stand 175 centimeters.

So rather than cite the China CSI let’s look at the China stock index fund MCHI. It’s priced in the same units as the S&P and other country funds. Whichever stands taller in the same units has outperformed.

In dollars then, it’s unambiguously clear that Chinese stocks have been in a bear market. On February 24, 2014, MCHI closed at $45.27. On February 26, 2024, it closed at $39.55. Lower than it did over a decade earlier.

But it wasn’t all downhill … on February 15, 2021, MCHI closed at $95,65. On January 22, 2024 it closed at $36.08. That’s a decline 62.3% in just under three years. I think that qualifies as a bear market by almost any definition.

I’ll go a step further here and call it an antibubble as well, to borrow the term from geophysicist-bubbleologist Didier Sornette. My usage is intended to reflect that the decline is best seen not necessarily as a self-instigating process but the result of the collapse of a bubble. Not to represent that that somehow makes it unique, as most bear markets are the result of prices having gone too high to begin with.

But once under way, like the bull markets that preceded them, they tend to acquire momentum along the way as investors tend to extrapolate the recent past into the near future and produce a self-fulfilling prophecy. In short, both bull markets and bear markets tend to go on longer and carry further than justified by the fundamentals.

The upshot of all this is that after a three year, 60%+ decline, prices may have reached a level that is below that justified by the fundamentals, laying the groundwork for a new bull market. I have not done an in depth analysis of those fundamentals, but people who have support this view. In particular, recent comments from Charles Gave at Gavekal opine that Chinese stocks now represent compelling value. And dividend yields are attractive … with the trailing twelve month yield on MCHI clocking in at 3.90%. Even just the chart gets my contrarian instincts’ attention.

Mine of course is not a complete analysis, but it is enough to merit a closer look for bargain hunting investors. Certainly those with a view that China may be getting its economic house in order are already seeing a bargain.

Interested investors could consider MCHI, or those like myself that prefer a less concentrated bet can consider a broader “emerging markets” fund like EEM or VWO, especially in the context of an otherwise China or EM-light portfolio. China makes up about a quarter of both.

 

18 thoughts on “Antibubble

  1. jk says:

    there are at least 2 difficulties in assessing the collapse of the chinese stock market. one is the collapse of the chinese real estate bubble, given the real estate has been a much bigger and more important market in which chinese invested and saved, while the stock market has been a bit of a casino. the other factor is the gov’ts ongoing crackdown on private companies, [e.g. the disappearance of jack ma, the killing of the ant financial ipo, etc], and also ever-increasing restrictions on information reporting even for local operations reporting to non-chinese owners. fdi has become a potential black hole, so flows are outward.

    1. Finster says:

      For sure, if it there were no plausible bearish issues, the market wouldn’t have fallen as far as it has. And even something down 60% can still fall another 60%. Still, if forced to choose between buying China at 25.6x dividends (3.90%) and the S&P at 68.9x dividends (1.45%) …

      … of course, fortunately in the real world we are not presented with such artificial dichotomies. I wouldn’t want to exclusively own either. But those who may find themselves neck deep in the investments featured in my last post might benefit by peeling off a bit of those and putting it into something less bubbly.

      1. Milton Kuo says:

        I am sorely tempted to load up on Chinese equities as I have a heavily overweight cash position. However, this article has made me realize that I have had three investments go badly thanks to government interference and I’m not willing to roll the dice with a fourth high-risk investment.

        Obama’s actions against the coal industry likely caused my equity investment in Peabody Energy to get totally wiped out. It was a down cycle in the coal industry so it’s possible I would have been wiped out anyway but Obama certainly didn’t help matters. The company was ultimately recapitalized and the coal mining industry today seems to be doing okay.

        Biden’s (as well as large institutions pushing ESG) actions against crude oil put a real scare into my investments in Chevon and ExxonMobil. The international oil companies are the only investments I made that the goverment tried to destroy but didn’t succeed. I actually made a very good return on shares of ExxonMobil that I purchased near the last bottom in October 2020. However, due to the heavy hand of the government, I purchased far less than I had originally intended (maybe 25% of my intended allocation).

        My most recent disaster occurred with Russian equities: Norilsk, Yandex, and Lukoil. Maybe my equity stakes in these companies will be restored once the war in Ukraine resolves itself, maybe not. There is a high risk that seizures of Russian state assets without due process will result in Russia nullifying all foreign claims on the Russian government and Russian companies. It’s also possible that those seizures will occur even without seizure of Russian state assets. This entire mess the wholly the fault of Biden and his thugs.

        I lost about 1% of my AUM with Peabody and 2% of my AUM with the Russian equities. Had my investments in Chevron and ExxonMobil somehow been wiped out, it would have cost me over 10% of my AUM. I didn’t get shaken out of my investments in Chevron and ExxonMobil due to stubbornness (“This is ridiculous. I am not selling. If I go bust, I’m going down with the Standard Oil ship.”) and due to my understanding that the War Machine does not function without crude oil.

        Investing in China is investing in companies that are rather opaque in their bookkeeping (that’s being generous), beholden to a thug communist government, and also at risk of thuggery from the lawless Biden government. I’ve already got about 2% of AUM in an emerging markets ETF that has been something of a dog with fleas for the nearly 10 years I’ve had the position. I’ve always been rather uncomfortable with how large a percentage Chinese equities have in the emerging markets ETF due to fears of financial chicanery and possible actions by either the Chinese or U.S. governments.

        So while Chinese equities do look inexpensive, I’ve had my fingers burned too many times on the stove to roll the dice on a price that’s not insanely inexpensive. To my horror, I would have done far, far better putting my money in seemingly outrageous things such as Bitcoin (I still think it’s the ultimate speculative game) or NVIDIA stock, both of which a friend in the finance industry suggested I buy in 2016 or earlier. I would have made over 100 times my money in those things, assuming I held until today, instead of looking at the real holes in my balance sheet.

        1. Finster says:

          Thanks Milton. To be fair, I haven’t claimed Nvidia was a bubble in 2016! And I’m sure you’re not suggesting buying it now is likely to be as profitable as it was then. Let’s see … for it to go up forty times from here …

          But that’s the problem, isn’t it? Buying a bubble asset can be extremely profitable … but only if you get it before it goes into a bubble. And if you’re savvy and disciplined enough to get out before it goes out of the bubble.

          There are never any guarantees. But I do think your odds are better buying something cheap than something expensive. The best single buy I’ve made was in 2003. Texas Pacific Land Trust (TPL) was just ridiculously cheap. Its balance sheet was strikingly simple: virtually no liabilities and just one asset. A little arithmetic revealed that each share was equivalent to about an acre of land at forty something bucks. At that price I didn’t care if it was frozen tundra. Over the next twenty years it went up two hundred times. Each time it doubled or tripled I sold a little and bought other things with it, always keeping it a meaningful but not overwhelmingly large portion of my portfolio.

          Would I buy it now? Probably not. But I’m not selling either; it pays a dividend that works out to about 160% yield on the original purchase price.

          Another key characteristic was there was zero excitement about it. Just a sleepy backwater that had gone nowhere for years. You didn’t hear about it on CNBC. You didn’t hear about it on Bloomberg or MarketWatch. Heck, even after it was up a hundred times you still didn’t hear much about it.

          I’ve had my share of disasters too. I loaded up on Canadian energy trusts not long before they were pounded by a tax change. I went heavy into MLPs near the top in 2014. Now I avoid making big bets on any one thing and make a point not to buy anything that’s hot without balancing it with something out of favor.

          What to do about China? If I’m suggesting anything, it’s to take a look. At recent levels, China makes up about 2.5% of world stock market cap. If your stock portfolio has less, you’re underweight, if it has more, you’re overweight. Just check that it’s where you want it. When I did this, I discovered I was a bit under and moved to a bit over via VWO. By itself this may not make much difference, but repeating the exercise on multiple fronts can add up over time.

          Does everything cheap turn out to be a good investment? Of course not. But the odds are better than what they would be paying hundreds of times earnings or book. And the more excitement there is about any investment, the less I want it. Excitement makes me want to sell.

          1. Milton Kuo says:

            >To be fair, I haven’t claimed Nvidia was a bubble in 2016!

            I did not see your earlier “Bubbles All Over The Place” article before writing what I did and there was no intent on my part of saying or suggesting you offered an opinion on NVIDIA, Bitcoin, or emerging market funds. If I did, it’s because I had a lot of ideas in my head and did a poor job of clearly expressing those ideas without intermingling them.

            I brought up NVIDIA stock and Bitcoin to point out that VWO Vanguard ETF of the FTSE Emerging Markets index (which has a fairly heavy China exposure) has done poorly since I bought it about or over a decade ago. Unless the ETF was bought during the 2016 low or during the COVID crash, the returns have been rather abysmal. On a capital gains basis, the fund has returned essentially nothing. The dividend yield is maybe between 3% – 4% over the years. I bought the ETF because it was not expensive and the U.S. was seriously engaging in blowing a new, even bigger bubble than the last two. I thought I was being prudent. About a decade later, the ETF is still not expensive and, looking back, the total return has been very disappointing.

            I brought up insane investments such as Bitcoin and NVIDIA (I felt that NVIDIA was overpriced in 2016) to point out that had I behaved like a crazed speculator, I would have done far, far better Just just better or far better; far, far better. That’s very irritating. 🙂

            However, beyond that, as my Russian equities adventure shows, there is a lot more risk than just bad (corrupt) management and the general risks in investing in equities in general. I did not think that NATO would intentionally provoke and escalate a war against Russia and make American investments in Russian assets illiquid or null.

            I think there is a reasonable risk that the current administration does something stupid that causes American investments in Chinese assets to become illiquid or nullified. As much as I disagreed with the way Trump handled the real problem of China’s trade practices (Trump targeted a specific country and he did it by name when he should have worked on establishing a general framework that countries that meet well-defined standards of predatory export mercantilism were hit with tariffs and trade restrictions), it was nothing like what the current administration has done.

            That’s why I’m saying that Chinese equities aren’t inexpensive enough for me to buy more than I already have in the VWO ETF. At the current price and assuming no asset forfeitures/seizures occur, I believe China’s stock market will do as about what the U.S. stock market has done in sane, non-bubble periods. At best. Throw in the risks of either the U.S. government or the Chinese government doing something, I personally would want a much, much larger discount.

            Perhaps if I were a Singaporean citizen that isn’t going to play these seizure games, the current price would be satisfactory. (I suspect Singaporeans that own Russian equities did not experience any real problems). But I’m not a Singaporean; I’m an American living in a kakistocracy/thugocracy where seemingly anything goes.

            The key points of my blathering: On price alone, Chinese equities are reasonably priced. Relative to American equities, Chinese equities are inexpensive. However, in my opinion, the political risks by an utterly corrupt Washington D.C. and a corrupt Beijing make buying Chinese equities at current valuations far less appetizing.

            1. Finster says:

              One of my core tenets of investing is the problem of evaluating individual assets in isolation. That they have to be evaluated as a whole. In other words, it’s never enough to say X is a bad investment … if all the others are worse it’s no contest … it’s either X or take a vow of poverty and join the brotherhood.

              Another is that there are no risk free assets. Even cash can lose up to 100% of its value. Probably the closest single thing is what I consider the default asset – gold – but even gold has had long losing stretches (eg 1980-2000). The lowest risk possible is in a combination of assets. So even X by itself won’t do.

              This is the framework imposed by reality. We can find fault with everything worth owning. And we should …. but our ability to find fault can’t ever be adequate reason alone to avoid something, because everything has its faults.

              So the question for China or EMs or anything else is always “What’s better?”.

              The S&P 500? Mag 7? Bitcoin? Bonds of a bankrupt government with few even attempting to tap the brakes on its descent into the abyss? Currency issued by a central bank that has promised to depreciate it by 2% annually, and which can’t even bring itself to slow the decline that much?

              Practically speaking, I think the answer is “None of the above”. The odds are better with “All of the above” … at the end of the day you’ll at least have something left that didn’t go to zero.

            2. Finster says:

              “That’s why I’m saying that Chinese equities aren’t inexpensive enough for me to buy more than I already have in the VWO ETF.”

              That’s my preferred approach. In fact the main reason I own VWO is that when I reviewed my portfolio I found I was underweight EM; one of my exUS ETFs caps it below market, so VWO patches up the gap.

              And while I was at it, went a bit overweight based on valuations. Personally the fact that it’s underperformed for a decade appeals to me. You can buy 2024 stocks at 2014 prices. Do not try this at home;-)

      2. Milton Kuo says:

        Drat. Forgot to add this to my previous comment.

        “Antibubble”? I don’t think so. China’s stock market is certainly a lot less expensive than the U.S. stock market today but it’s about as expensive as what the U.S. stock market regularly used to before the Greenspan serial bubble-blowing era. Maybe if the Chinese stock market fell another 50% or maybe even another 80%, that would qualify as a true antibubble. 🙂

        For what it’s worth, the Russian stocks were extremely inexpensive (understandably) when I purchased them and with the exception of Yandex, they all paid a strong dividend, had been doing so regularly for years, and had hard assets to back up the stocks’ valuations.

        1. Finster says:

          Formally speaking, an antibubble is a thin film of gas surrounding a drop of liquid, in contrast to a thin film of liquid surrounding a drop of gas. Wikipedia: Antibubble. (Apologies to Didier Sornette.) So unless the Chinese stock market is a liquid filled gas film, it’s safe to say formal definitions are out. That leaves us in pretty subjective territory.

          We need context for that. My use of the term is a somewhat tongue in cheek way to contrast the Chinese stock market with Nvidia and bitcoin. This was originally going to be part of the same post, but I thought it worthy of its own entry and that it would be sufficient to incorporate by reference the necessary context.

          The real issue of course isn’t semantics but the merits of an investment in Chinese stocks. But that requires context as well. Two investors could both think them attractive. One might decide to chuck it all and put 100% of his initially well balanced portfolio into Chinese stocks. Another might be starting out with 100% in Nvidia and bitcoin and decide to diversify 10% of that into Chinese stocks. If any part of my post sounded like a suggestion to do the first, I hereby expressly disclaim it.

          A broad gray area lies between the extremes. Some have called the Chinese stock market “uninvestable”. Others, like Gave, regard it as very attractive. For most, it’s not a question of whether but of how much.

          Could something go wrong? Investors using that as test for investability may as well take a vow of poverty and join the brotherhood. Every investment involves risk. As should be clear from my last post, I see it high wide and deep all over Nvidia and bitcoin, yet have a little of them anyway. For the average investor, you almost have to go out of your way to avoid it.

          The Chinese stocks proposition isn’t all that different. But it’s a different kind of risk … the difference between owning something that’s soared over the past few years and is wildly popular with the crowd versus something that’s plunged over the past few years and is deeply out of favor. In this sense, if the former can rightfully be called a bubble the latter can rightfully be called an antibubble.

          If I had to distill a takeaway into a single sentence, it might be this: Counterintuitive as it may seem, it’s more risky to have only one of these kinds of risks in your portfolio than both.

          1. Finster says:

            Barron’s reports that the aggregate earnings for the S&P for the fourth quarter were up 4% from the year earlier. The price of the S&P was up 24.6% from a year earlier. The difference is pure asset price inflation.

    1. Finster says:

      If so, an allocation to commodities and emerging markets should diversify even better. Diversification means never being forced to choose.

      EMs are about 10% of the global stock market, so if your stock allocation has less, you’re underweight, if it has more, you’re over. I think it’s less important exactly what investors choose than that they make a conscious choice to begin with. Know where you stand. Personally I don’t do China per se but have an EM position via VWO; that way you get India, Brazil, Taiwan, etcetera too. FWIW I’m almost by default overweight every foreign market by virtue of being underweight US. Though that’s partly a consequence of my income objective, given that ex-US markets yield two or three times the US. The choice for those speculating more on price performance would be tougher.

      Thanks for the PortfolioCharts link. I’m a fan.

    1. Finster says:

      They sure have been rockin’ … gold just hit all time highs … and FWIW I’m nicely overallocated, so you might say I think there’s more where that came from. Whether it’s in the next few weeks or few years …

      Interesting that gold is again solidly higher today even as its heavily marketed supposed digital substitute is down sharply. Bitcoin is big enough now to argue for a small position based on global market portfolio theory alone, but it is no substitute for gold. Man made money has never been.

  2. Finster says:

    In the nine weeks since the end of February the EM fund VWO is up 5.43%, versus the broad global market VT up 0.13%. The more targeted China fund MCHI is up 14.05%.