Wednesday, July 23, 2014

Comment on China's "History of Recurring and Traumatic Financial Crises"

y0ungmoney posted this as a comment on the China "History of Recurring and Traumatic Financial Crises" post.

I think the lack of property rights in China (and emerging markets more generally) will become a big issue when we have a real EM downturn. It will lead to widespread revulsion-- people will think, "Not only are my EM stocks down 85%, they're going to screw me out of whatever I have left!"

It's the kind of thing that's easy to ignore in a bull market and impossible to ignore once things go bad.
One principle of social mood is that it isn't news that drives market valuations, it's people's mood-based reactions to existing news. Everything needed for the Shanghai index to trade at zero is already known; but people's extraordinarily positive mood prevents them from properly incorporating the information. I wrote about this in my Review of Benjamin Graham and David Dodd's Security Analysis:

"One frequent observation about Graham and Dodd's era is that they had it kinda easy, what with being able to buy lots of net-nets - companies selling for less than their current assets minus total liabilities. Here's how common these opportunities were:
'Our computations indicate that over 40% of all the industrial companies listed on the New York Stock Exchange were quoted at some time in 1932 at less than their net current assets.'
I have never heard anyone stop to reflect on why valuations were so low during the Great Depression. Why didn't anyone buy those compelling values? Those valuations indicate revulsion, which Hussman defines as:
'A growing impatience among investors who conclude that stocks are simply bad investments, that the economy will continue to languish, and that nothing will work to help it recover. Revulsion is not based so much on fear or panic, but instead on despair and disillusionment. In a very real sense, investors abandon stocks at the end of a bear market because stocks have repeatedly proved themselves to be unreliable and disappointing.'
Impatience also with fraud. Shame with being scammed by a flimflam mortgage guarantor or a stock scam.

To read the Lehman Brothers bankruptcy examiner's report, or the New Century Financial report, is to realize that we might reach 1932 valuations before this is over.

If you can't trust a financial institution's balance sheet and you can't rely on the auditors or the bank regulators to do anything, you are going to demand a huge risk premium for the surviving institutions' securities."

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