Another day, another crash...
Another day, another crash... Why Chinese stocks are falling... Why China's currency is plunging again... China's balancing act...
Chinese stocks are crashing again...
On Monday, the large-cap CSI 300 Index plunged 5%, triggering the market's new circuit-breaker system, which halted trading for 15 minutes. When trading resumed, stocks fell another 2%, and trading was stopped for the rest of the day.
The benchmark Shanghai Composite Index ended the day down nearly 7%.
The same thing happened this morning.
In fact, the market plunged 5% in just the first 10 minutes of trading. After a 15-minute halt, the market plunged another 2% in five minutes, shutting down trading for the day less than 30 minutes after the market had opened.
The Shanghai Composite Index ended today down 7.2%. Chinese stocks have now fallen more than 12% to start the year.
As we discussed on Monday, China's new circuit-breaker system has backfired. Rather than helping to prevent declines, it's actively making the selling worse.
And now, it appears the Chinese government agrees...
Just four days after rolling the system out, the government has officially suspended it. As Bloomberg reported this morning...
China's securities regulator suspended a new stock circuit breaker after a selloff forced local exchanges to shut for the second day this week, signaling that the country's leadership may reconsider or change the system.
The China Securities Regulatory Commission (CSRC) announced the suspension on its official microblog account on Thursday night. The decision came hours after CSRC officials held an emergency meeting to discuss conditions on the nation's tumbling stock market, according to a person familiar with the discussions who asked not to be named because he wasn't authorized to speak publicly.
True Wealth editor Steve Sjuggerud shared his thoughts on the news with us in a private e-mail this morning...
The Chinese government expected this system would give investors a feeling of safety and security – that the market couldn't fall too much in a day.
The outcome was the opposite... Fear, volatility, and panic are ruling China's markets, significantly due to these government-created circuit breakers.
But instead of reducing volatility, these "circuit breakers" have dramatically increased it. Here's how it goes... As stocks start to fall in China, investors quickly start bailing out, so they can get out ahead of the 5% circuit breaker. Then, once the 5% threshold is hit, panic sets in and lots of sell orders hit to get out before the market is shut down for the day at the 7% level.
Steve says it isn't the system itself that's the problem. Most markets – including those in the U.S. – have them. This one was just poorly designed...
In the U.S., trading is halted for the day if the stock market falls by 20% in a day. (Before we hit the actual shutdown point, trading is halted for 15 minutes if the main stock index falls by 7% and then by 13%.)
The problem in China is, the thresholds (5% and 7%) are just too darn tight.
After two horrible trading days in Chinese stocks the Chinese government decided to "suspend" its circuit-breaker system (for now).
Unfortunately, this week's declines triggered stop losses on some of Steve's China recommendations.
While he still believes Chinese stocks have incredible upside over the next five to seven years, regular readers know Steve believes managing risk is the most important thing any investor can do. (He was the first Stansberry Research analyst to recommend trailing stop losses.) As he wrote...
This is fine. It is the way it will be... We will take a few losses on the way to what could potentially be hundreds-of-percent profits.
I expect the Chinese authorities will get this sorted out. Then the next thing will come up, and they will get that sorted out as well. This is all "growing pains" on the way to becoming a legitimate financial superpower.
Me? I am following my stops and cutting my losses in some China trades.
When the uptrend returns, I will be back... I don't know when that day will be. But I do know that China is a long-term story that I want to be a part of...
As we noted yesterday, China's currency – the yuan – has also been plunging... and this has rattled markets around the world.
The People's Bank of China ("PBOC") set (or "fixed") the yuan 0.5% weaker versus the dollar compared with Wednesday – the biggest one-day move since it devalued the yuan by nearly 2% in August. After similar declines earlier this week, the yuan now sits at its weakest level versus the dollar since March 2011.
While the speed of the decline is concerning, it's likely confusion about the reasons behind the decline that is worrying markets the most...
As a quick review, in August, the PBOC made a big change to the yuan...
Rather than using its trillions of dollars of currency reserves to keep the value of the yuan closely tied to the value of the U.S. dollar – as it had for years – it decided to allow the yuan to trade more "freely." In short, this involves letting the market decide where the price of the yuan is set each day. The 1.9% devaluation that month was the initial step to move the yuan closer to its market value.
But the reason China made this change was not entirely clear...
Some analysts believed it was a new "salvo" in the currency wars... It meant China was in worse shape than believed, and the government was looking to boost the economy by making its exports cheaper to the rest of the world.
Others suggested it was meant to satisfy the International Monetary Fund ("IMF"), which said the yuan must be "freely traded" before it would be included in the group's basket of world reserve currencies.
And still others said China had no choice in the matter... It was fighting a losing battle, spending tens of billions of dollars every month from its currency reserves to prop up the yuan, while every other major currency fell against the dollar. In this case, China's goal would be to let the yuan decline gradually, while acting as necessary to prevent an all-out crash and currency crisis.
The real story may be a combination of all of these...
The latest reports confirm China's economy is slowing.
We learned last month that the IMF supported the August change, and agreed to add the yuan to its basket of reserve currencies.
And recent data show China's currency reserves declined by hundreds of billions of dollars last year, a pace that could exhaust its reserves entirely in just a couple of years.
Regardless of the reason, this week's moves in the yuan suggest more downside is likely.
And until or unless China explains its intentions, we can't know for certain how far these moves will go... or how long this turmoil will last.
New 52-week highs (as of 1/6/16): short position in Capital One Financial (COF), short position in iShares MSCI Canada Index Fund (EWC), Nuveen Municipal Value Fund (NUV), short position in Santander Consumer USA (SC), and short position in Suncor Energy (SU).
A busy mailbag today... one subscriber weighs in on Porter's Capital One "short," another shares his experience buying his first bond, and several more share how their portfolios are holding up. What's on your mind? Send your thoughts to feedback@stansberryresearch.com.
"Your shorting of Capital One Financial is spot on because of all the evidence you have brought forth on the creditworthiness of their customers. But have they learned their lesson... NO! The following is an example.
"My son is two years out of college and is working part-time in his field of study. He had to move back home because he couldn't afford the expenses of renting an apartment with a friend. He's on the income contingent payment plan with his student loans and he pays some of his loan when he can, but there's Capital One every month sending him a credit card in the mail. Baiting him with $1,000 credit line, 0% interest on purchases for three months, and cash back. I don't know what his credit score is, but I know it's not very good and I'm sure Capital One knows that his credit score is not very good also. Every month for the past eight months he gets another offer from them. No other credit card company has sent him anything so that tells you they're desperate for those high interest charges. Well, when all those subprime loans default they will get exactly what they deserve. Keep up the good work." – Paid-up subscriber Kenneth S.
"Dear Porter, I have been an investor since January 1994 but only in stocks. Since subscribing to Stansberry's Credit Opportunities last month, I have educated myself the last couple of weeks about buying bonds by reading the monthly newsletters on your website. I gave some thought to the total amount of my portfolio I intend to invest in bonds and will spread that portion of my portfolio over the 15-20 bonds Stansberry's Credit Opportunities will suggest over the next 3 years or so, arriving at an amount that I will invest in each bond. With that figure in mind, today I made the decision to take the plunge and 'buy a bond.'
"I keep my IRA with Scottrade, so I went into my account and began to look for how to buy a bond, sensing that this would not be difficult. I called my Scottrade representative to determine the exact steps I needed to do, and discovered that once I learn how to do it, buying bonds online is very easy with them. The gentleman walked me through the tabs to show me the basics. I then gave him the bond CUSIP for the bond recommended in the 11-11-15 newsletter, and together we entered that CUSIP in the field of the bond tab, and selected 'find bond.'
"Sure enough, the web page showed about 7-8 bonds at different prices, with varying minimums that I had to purchase. The smallest minimum indicated 5, and that was about what I had decided to purchase anyway. I then selected that bond, clicked, it asked how many I wanted to purchase, I entered the number, it showed my transaction, and I confirmed it. For this particular bond you suggested paying no more than $700 and I bought it today for $660.54, thus positioning myself for even better returns when the bond matures. Thanks for your encouragement, teaching us the basics, and sharing these opportunities with those of us wanting to make higher returns and willing to do something a bit different to earn higher returns." – Paid-up subscriber Russ S.
"The only thing that looked good in my portfolio today was the down movement in my short sells in SC and GM. Thanks for your recommendations to short them. Too bad I had never shorted a stock before and started out pretty slow to see how easy it was to do on my own through my E-Trade account.
"Concerning the first ship load of oil leaving the U.S., I wonder if it was China shipping their 1st load of oil from the wells they purchased in the Eagle Ford or from the Permian Basin and therefore not purchasing from a U.S. producer. I think China screwed us again on that deal. I guess you are aware that China has bought up over $17 billion of our U.S. natural oil resources in eight states including the Eagle Ford, Permian Basin, Bakken, the Marcellus Shale, and others. Thanks again." – Paid-up subscriber B.J.
"Thank goodness (and Porter) I added 7 of the 10 for 10 gold recommendations immediately (with the other three to be added sooner than planned) and they helped keep me & my portfolio above water the last few days... interesting times, I must say. Thanks for all you guys do. Happy New Year to you all." – Paid-up subscriber Chris K.
"NOT panicked. Have built up cash per Porter's notes. Sitting with about 18% cash. Buying Porter's bonds + quality companies." – Paid-up subscriber Frank Jay
Regards,
Justin Brill
Baltimore, Maryland
January 7, 2016
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