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WESTERN MARKET FENG SHUI

Recently as I watch the volatile stock markets in China, more out of curiosity than as an actual investor, I am reminded of some of the stock market wisdom my father taught me, garnered from his two decades of experience as a stock broker in Canada.

As China’s Premier, the PBOC governor, and other officials rush to the press to reassure investors every time there is a fluctuation in domestic markets, I believe that what China’s markets really need is more Western-style investor education, and where better to start than with understanding the animals of the Western stock market zodiac, or what I will localize as Chinese investor feng shui.

Let’s test your investing feng shui IQ: Do South China Tigers bounce?

Near the end of March, when the markets in China were on a roller coaster, punctuated by a five percent plus drop in the Shanghai index on one Thursday and a near mirror-image rally the day after, I was reminded of the somewhat morbid concept of a bouncing cat. With all the recent purported sightings of South China Tigers, one may ask, can a big cat bounce? The answer, amazingly, is yes, if it is dropped from sufficient height. However, and this is the salient point investors need to pay attention to, the cat will then be dead. The bounce, in other words, is not expected to be of much use, least of all to the poor feline.

Traders have long used the term dead cat bounce to describe a rally or jump in a stock or market that is short-lived at best. As the Chinese stock markets have dropped dramatically from their 2007 peak, when Shanghai’s index was the world’s best performing market at 97 percent on the year, it looks possible that in 2008 their performance may be among the worst. Yet, on the way down, from so high up, we may expect there to be bounces, technical rallies, as happened that mirror-image Friday when the index gained nearly five percent after a sharp drop the day before.

If investors choose to follow this wisdom, they will not be fooled into thinking those rallies can be sustained, because the underlying fundamentals of the market decline – interest rates and inflationary pressure, reduced exports, falling corporate profits, and overall market sentiment – remain in play. With China’s political leadership collectively saying, “It’s going to be ok”, smart investors should next be asking, can you put lipstick on a pig?

Again, in stock market lore, the answer is a resounding yes! This expression means to make a bad stock appear better by using cosmetic enhancements. Such metaphorical lipstick has been put on stock market pigs for decades. Premier Wen Jiabao said to the press during his recent trip to Laos that one of the primary purposes of the government is to

“establish, through legal means, an open, fair and transparent market environment so as to protect the interests of investors and small shareholders.”

Those investors should wonder if this was merely meant to help stabilize the rapidly falling markets, and was there any real substance to the announcement?

With the Shanghai Composite Index dropping about 20 percent in the month of March alone, market talk from leaders may result in a temporary halt to the decline, but the pig is still ugly and long-term attractiveness will take much more than just cosmetics. But the political leaders’ comments beg the question, why was there so much volatility in March, anyway? Could somebody be shaking the monkeys off the tree?

Does the March sell-off indicate a healthy correction to the 2007 run-up, or is it driven by panic selling from the small investors? My father might ask, are there some big gorillas shaking the tree to make the monkeys fall out? This is one of my favorite expressions, referring to the ability and propensity of large fund and institutional investors to use their holdings to push down the values of individual stocks, even markets, by using large sell orders to panic the small investors. Later the funds come in to clean up at lower prices.

Market psychology in China’s volatile investment environment, compounded by the habit of older shareholders congregating in the brokerage lobbies and sharing stock rumors and trading tips, is especially fragile and easily distracted by short-term changes in stock price.

The small investors here should learn from their US investing brethren, who have left behind the heady days of the Dot-Com bubble and its day-trading millionaires for a return to the long-term value-investing approach. When the gorillas shake the tree, if the stock’s fundamentals and news are still strong, this can be seen as a buying opportunity to cost-average stock holdings at a lower overall valuation. So Chinese investors should save the short-term sell order and instead buy and hold for the long-term, because there are two more animals to learn from in market feng shui, the bull and the bear.

Long-time market players know there is no way to predict when to ride the market upswings – the bulls – without hitting some of the corrections – the bears. However, one thing is true over time in healthy stock markets, bulls reign over bears. Bears may lumber and growl, but they eventually go back to hibernation. Bulls, on the other hand, will always be ready to charge again. Running with the bulls, and waiting out the bears, has been the best strategy in the US stock market for the last one hundred years.

Chinese investors can learn two things from market feng shui: Old stock market wisdom can have merits, and don’t be scared of the animals.

(c) 2008 Jason Inch (Originally printed in the Shanghai Star, April 7 2008)

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Jason Inch

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