The Ignorant Investor

I continue to be amazed by the rise in Chinese stocks. Put aside all the talk of the power of free market capitalism and the promise of 1 billion consumers and rising wealth for a moment. That may be true and important for the long term growth of the country's economy, but let's focus on the short term like markets do.

This is still a country without democracy, without a legal structure that recognizes and enforces property rights, without a free floating currency, and without any transparency in the methodology and collection of its economic statistics. According to everything the anti-socialists at the Heritage Foundation and American Enterprise Foundation have been telling us about economic determinism over the past few decades, this is an economic system that should be at serious risk of heart failure. But who cares about quibbling over such details when big heaping piles of money are being showered on owners of Chinese stocks? When the commies are making big bills, politics and ideology go out the window.

As always, nobody in a position of power wants to call the Chinese stock market a bubble. I saw an interview with Warren Buffett the other day where he just shrugged his shoulders when asked about the market. Maybe it's overvalued, he seemed to say, and maybe it's not.

At this point, the iShares FTSE/Xinhua China 25 Index (FXI) is up 65% since January. And the explosive growth hasn't happened just this year. A share cost around $53 in January 2005; it's now up to $217. How high can it go before tanking? And let's face it: it's going to tank. It might not drop all the way to $53 again, or even $100, but exuberant markets always tank. This is almost a law of the universe. Like gravity. Or the fact that odd numbered Star Trek movies always suck. We saw it in the late 1990s, we're seeing it in housing prices now.

Forbes compared the Chinese market to the famous runup of the NASDAQ during the stock and had this to say: From its August 1998 low to its record highs above 5,000 in March 2000, the NASDAQ registered a 240% gain--less than half what Shanghai has posted in the last couple of years.

Now keep in mind that we're not talking about the average runup of an American bull market. We in America are an optimistic people and we like a good bandwagon as much as anyone else in the world. When we see markets shooting upwards, we hop on board for the ride. We fear being left behind more than we do losing money. So we got out of control during the late 1990s and got a good sharp spanking by Mr. Market in return.

Now it turns out that as crazy optimistic as we then, investors in China are even crazier now. Who'd have thought that was possible? It's like they're pushing the envelop of optimism.

I continue to have faith in the laws of the universe. When the trendline in share prices starts resembling a ski jump, that's a sign of a coming crash. Now if only I knew when the thing would start falling, I could actually make some money with this prediction.