China’s Big Bear Market – A Silent Scream

We have written previously about investors having a “risk-off” year as various markets have to deal with inflation, the central bank’s response to inflation, overvaluation, overindebtedness, supply chain issues, and now, the Russian invasion of Ukraine.

So far this year, it indeed has turned out to be a “risk-off” event as we predicted.  It has been made even worse by the Russian incursion.

Our focus has mainly been on the U.S. but when viewed with a wider angle lens, the picture is beginning to look international.  

As readers might be aware, financial terminology is not always exact or descriptive. But normal usage is a drop of 10-20% is considered a “correction”, while anything over that is considered a “bear market.” Conversely, a rise of 20% or more is considered a “bull market.”

We are not sure that a person who loses 19% in a “correction”, feels that much better than someone who loses 21% in a “bear market”, but that is the terminology generally used. We also think that there are internal market differences between corrections and bear or bull markets, that go well beyond simply percentage changes. But we will leave those technicalities for another day.

As we write, the broad US market as defined by the S&P 500 has suffered losses of about 15% and we expect a bounce fairly soon. After this bounce, then we will find out if losses will be more severe and protracted. 

However, that is not the full story. Almost half of the companies inside the S&P have fallen much more, many upwards of 50%. In short, there has been a bear market in many individual issues.

The broad index of technology, the QQQ, or the 100 largest companies in the NASDAQ has lost 22%, putting that index in bear territory. The Russell 2000, which is supposed to track smaller capitalization companies, has also dropped just a hair beyond 20% as well.

So, it is a mixed bag in terms of official labels. Larger cap indices are in “correction”, while the NASDAQ and smaller cap indices are now slightly into bear territory.

Even worse carnage has been seen in foreign markets. The German DAX is down around 29%.  The French CAC is down about 22%, Spain down a similar amount, and Japan is down almost 20%.

Among the most important, is that of China.

China is important not just because it has the second (some say first) largest economy. It is also important because many world leaders like the Chinese model of government/corporate unity.

Some call it state-sponsored capitalism. In China, you have a blend of state-owned enterprises, with “private” corporations that have government leaders on the board. Members of the People’s Liberation Army sit on the boards of most large Chinese corporations. Many US business leaders increasingly like the model, or at least they behave as if they do.

As an important aside, the term “state-sponsored capitalism” or “crony capitalism” is not helpful because it is both misleading and confusing.Free enterprise is supposed to be free.  Other than setting basic legal ground rules, the government should not participate in free enterprise. If the government does, it obviously isn’t free, because the law is a compulsion.  It is more properly called fascism.

It has never really been defined when a so-called “mixed economy” reaches the borderline of fascism. How much government meddling is permitted before you cross the line?

At any rate, what happens in China is important because their economic model competes with ours, and they are simply the second biggest kid on the block.

What we see in China certainly qualifies as a bear market and a big one at that. This has also come with considerable real estate troubles, including the bankruptcy of the giant Evergrande real estate conglomerate. The largest debtor in the world has defaulted on more than $300 billion in loans.

The Dow Jones China 88 is now down over 33%. Note that while U.S. stocks began their decline in early January of this year, China rolled over in February of 2021, more than a year ago.

The Invesco China Fund, a prominent US-managed mutual fund of Chinese shares is down a whopping 45%.

Alibaba Group, the Chinese clone of Amazon is down 73%. Tencent, the largest cap of all tradable Chinese companies is now down 55%.

This kind of severe damage has garnered little press, in part because President Xi is trying to cover things up for his third term, and in part, because our press and our elites are sympathetic to Chinese fascism. In fact, many of our biggest corporations, media companies, and sports organizations; are invested heavily in China. They turn a blind eye to the fascistic system as well as the genocide against ethnic and religious minorities. Now they are turning a blind eye to significant losses.

It would seem ESG (Environmental, Social and Corporate Governance) U.S. corporations don’t care about the “social” and the “governance”, as long as slave labor is profitable. And, if taking care of shareholders now plays second fiddle to other “stakeholders”, those investor losses are secondary as well.

But many Chinese and Western investors are now suffering in silence because no one wants to say what is obvious out loud: China is in a bear market.  The theory that “they”, usually meaning the Chinese government, won’t let large losses occur, has been debunked.  It may be more accurate to say these larges losses have occurred because the government plays such a large role in Chinese corporate life.

This kind of damage in equity markets rarely occurs unless there are severe underlying economic difficulties. With so much debt being held by state-owned banks that can hide the losses, it is hard to know for sure. If true in this case, the bear market in China is quite significant. And the fact that bear markets exist in many other powerhouse nations such as Germany, is equally significant.

Historically, the truly big and dangerous business cycles are worldwide in nature. The “risk-off” year seems now to be going global and that will create additional difficulties for those of us in the U.S.  Bear markets in most of the large economies of the world will not be without consequences.