China on Margin

The global markets have seen heightened levels of volatility relating to the news out of Greece, China and the potential interest rate hike here in the United States. Matt wrote a little bit about this at the beginning of July. The Chinese stock market collapse is of particular interest because it is occurring to a very underdeveloped stock market but also in one of the most important economies in the world. This is a rare combination. 

When we call the Chinese stock market underdeveloped much of what we mean by this is the lack of regulation and structure but, most importantly, a lack of risk management and understanding by it's investors. Margin investing seems to have become a prevalent thing in China. One of the largest risks with margin investing is being hit with a margin call. Unless investors have other money to cover the calls, they must begin liquidating their investments to cover. Having to cover margin calls in a crashing market can quite literally put you into financial ruin. Losses can go well beyond your initial investment. Small losses can quickly turn into large ones and spark market wide sell offs.

This isn't the only issue in the Chinese markets but one that is a sign of "irrational exuberance". China remains a concern but as we have mentioned the bigger concern is the strength of their economy. It seems the consensus is their economy remains in good shape. This is partly due to the low participation rate of the Chinese in their own stock markets. 

If the Chinese economy slows then we certainly expect to see negativity in the global markets. You don't have to go far down the list of growth areas for US companies to find China being an important part of their plans. In our opinion, the Chinese consumer remains the most important cog in the global economic wheel at the moment.