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"Greed Is King" - What We Learned Talking To Chinese Stock Investors

Authored by J.J. Zhang, originally posted at,

Though Greece has dominated the news recently, its overall market impact has been surprisingly muted. Instead, the real market mover and shaker for the last couple of months has been China.

By now, many are familiar with the facts and numbers of the Shanghai market situation. But recent events have also shed a light on a less well known dynamic — the individual behavioral habits and viewpoints of Chinese market participants.

During a short stay in Shanghai a few weeks ago on unrelated business, I had an opportunity to witness the ground zero of the China market frenzy at its peak and its nascent plunge. Chinese retail investors make up 85% of the market, a far cry from the U.S. where retail investors own less than 30% of equities and make up less than 2% of NYSE trading volume for listed firms in 2009.

Combined with the highest trading frequencies in the world and one of the lowest educational levels, describing China’s market as immature is an understatement. As many readers know, mental irrationality is often cited as the No. 1 cause of poor returns.

Using the opportunity to interview some China market participants, both in Shanghai and elsewhere, here are a few observations of how they think and act — and the potential lessons that await.

Bubbles can be surprisingly predictable

During the housing bubble run-up and subsequent recriminations, a common excuse was the impossibility of predicting and diagnosing bubbles. However, bubbles can often be characterized by several irrational behaviors and metrics and the recent China bubble is no exception. Almost everyone in the financial industry knew the Shanghai market was in a bubble. Interestingly, from my interviews with everyday participants, they knew it as well, many agreed that the market was crazy and was likely in a bubble. It was not a question of if, but when, the bubble would pop.

Chasing bubbles in China isn’t new

An interesting counterpoint to the bubble awareness is that, frankly, Chinese participants are used to chasing bubbles. Whether a cultural phenomenon or something else, over the last decade there’s been a continual hopping of investment from one big money-making scheme to the next. Whether it was real estate a decade ago, gold half a decade ago or wealth-management products a few years ago, there’s a continual cycle of money rotation into the “hot” investment, with each failing eventually in some way. It’s simply stock’s turn. As one interviewee said: “The Chinese market is not for investing, it’s for gambling.”

Early birds get the worms

This goes completely against most prudent and established norms. While the standard advice is to avoid “hot” bubbly assets, in China the experience has actually been to jump in early and fully instead. Many of the bubbles or “hot” investments mentioned earlier have in truth made many of the people I’ve talked to a lot of money. China real estate today is a poor investment but those who got in early doubled or tripled their investments. Similarly with wealth-management products, more people have benefited from their high-interest-rate payouts than have suffered. While the Shanghai market has dropped 20%-30% from its peak a few weeks ago, it still represents a 100% gain from a year ago and a 30% gain over the last 6 months. Those participants who jumped in early are still more than happy.

Greed is king

Despite recognizing it’s a bubble, almost everyone was still all-in on stocks. Why? Quite simply — greed with a dash of jealously. Seeing constant market gains in the news along with daily sharing and boasting from friends and family getting rich is simply too tempting and thus caution was thrown to the winds. Subsequently, this fueled a massive amount of equity exposure followed by leveraging and margin borrowing to go even more all-in.

But fear is the emperor

The only emotion more powerful than greed is fear. Almost everyone I talked to was still all-in on stocks but everyone had a foot halfway out the door, ready to bolt at the first sign of trouble. While not uniquely a China problem — market drops are almost always more violent than the initial rise — in China, it’s several times more volatile. Look no further than solar-panel firm Hanergy’s Hong Kong listed stock, which lost 47% in one hour, or the numerous days the Shanghai market rose or dropped by 5% or more.

Moral hazard in government rescues is real

During the most chaotic moments of the financial crisis, bailout discussions always raised the specter of moral hazard. While it didn’t play a major role in the subsequent U.S. recovery, moral hazard in China is fast becoming a deep problem. Many market participants I talked to said they were confident in the Chinese government to step in eventually to maintain order and prevent mass panic. They know the government’s legitimacy relies heavily on economic progress and fear any contraction. So far, they’ve been right — the government has announced a never-ending stream of interventions over the last few weeks to stem the selloff and panic, with the latest being the implementation of a half-trillion-yuan fund to purchase stock and shore up the market. Of course, the question is: When does a problem become too big for the government to control?

Maturity takes time

Perhaps the last lesson I took away from my Shanghai experience: Maturity takes time. Just as kids grow from naïve adolescence to rowdy teenage years to eventual maturity, so will China and its market participants. While stocks have been a part of U.S. culture and wealth creation for several generations now, in China this is really the first generation where participants both have the money and the ability to invest in stocks.

Perhaps in another generation, after several years of painful lessons and surprising opportunities, it’ll look completely different.

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[ZH: Just like US investors have learned...