"The China Syndrome" Lessons from Confucius and some others

China's stock market pattern is beginning to remind me of Japan's "irrational exuberance" as witnessed in the early nineties where a decade of fantastic growth was followed by a decade of flat to lower stock prices. I struggle many times to wonder why investment dollars flow to a country with serious human rights issues and a government that borders on oppressive. But the fact remains that China's GDP growth north of 10 percent in the last few years is big enough to wake Chinese philosopher Confucius out of the grave to take notice and teach us a few things.

"In a country well governed, poverty is something to be ashamed of. In a country badly governed, wealth is something to be ashamed of." Confucius


High energy demand and pricing, a lack of corporate governance and financial accountability to shareholders, hard-lined policies with respect to a free market currency and unfair trade practices are sure to bring the flying dragon down lower to earth. Investors should remember well the events of 10 months ago when a one-day 9% meltdown in Chinese stocks rippled around the world sparking a 400 point sell-off in the Dow Jones Industrials that day. Since then, there have been two other sell-offs in Chinese stocks this year following the US Market's lead.

"He who sacrifices his conscience to ambition burns a picture to obtain the ashes." Confucius

As I write this post, China's Hang Seng Index dropped overnight by 716.45 points or (2.42%). This follows a sharp rise in the prior two sessions of nearly 2 percent. When one sees this kind of volatility near the all-time highs, its time to get cautious or face the music when something bad happens.

"He who will not economize will have to agonize. Much wealth will not come if a little does not go." Confucius


There exists well documented over-valuations of stocks that exist in this market as evidenced by the recent PetroChina deal that came public. Even Warren Buffett made a killing on this deal, but he was quoted recently saying that finding a similar great deal in China now was a struggle in China's "too hot" stock market.

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful, It's only when the tide goes out that you learn who's been swimming naked". -Warren Buffett


He, like some other Wall St mavens have now started to realize that China is overvalued now. However either there are not enough analysts out there to warn investors, or maybe they are just walking as blind as the bond ratings agencies were a year ago who failed to warn us of the sub-prime mortgage crisis. Maybe the big Wall St firms are afraid to tell the truth for fear that their mega-million dollar Chinese IPOs will come to a crashing halt if they get too bearish on the region. It does happen you know.

"An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today." Laurence J. Peter (1919 - 1988)

China now faces 6.5% inflation, a ten year high, and if that isn't enough to create some headwinds, another item I read at the Economist Website while researching this post which I thought was alarming was the under-publicized energy shortage that now exists in China. This crisis has certainly been the driving factor behind Oil's price rise to boiling temperatures and there seems to be no end in sight. (For the record I am still playing the volatility in oil with neutral options positions)

"Ability will never catch up with the demand for it." Confucius

"If inflation continues to soar, you're going to have to work like a dog just to live like one. " -George Gobel


I am initiating a position in the Proshares Ultrashort FTSE/Xinhua China 25, (FXP - AMEX ), a newly launched ETF that is designed to double the inverse daily return of Chinese stocks listed in the FTSE/Xinhua China 25 Index. It closed yesterday at $62.10 and will probably open much higher at the open, but for investors looking out six to nine months this represents a great way to play Chinese stocks to the downside. I didn't have the luxury of ETFs that short the market 15 years ago when Japan's market fell out of bed, but I see another opportunity now and the instrument to do it.

"By three methods we may learn wisdom: First, by reflection, which is noblest; Second, by imitation, which is easiest; and third by experience, which is the bitterest. " Confucius

To all the Chinese investors reading this post, don't worry I have high hopes for China in the distant future as an investment but near term leading up to the Olympics in August, I see a major correction coming in this market which will by then make stocks of the "asian persuasion" attractive again.

"Our greatest glory is not in never falling, but in rising every time we fall. " Confucius

As for all the other novice investors who have been jumping into the Chinese market the last few months:

"Man who run behind car get exhausted. Man who run in front of car get tired." Confucius

"Virginity like bubble. One prick - all gone!" Confucius

I will be adding a new position in FXP on the next up day in the Chinese market.