I have no idea if this is true or not. It is merely conjecture. However, this scenario is certainly possible.
The Shanghai Index (FXI) was down 22% top to bottom before recovering a few days back, with the market gapping down to the low then recovering to close at the daily high. Since then, the last few days have been relatively stable while western markets have been getting cracked. When I wrote this, the Nikkei was down 300 points, Shanghai had barely budged, but still, somebody was in a buying mode.
I have been reading reports that there have been demonstrations in China, even riots, as investors who'd hocked the house deeds to pawn brokers charging 3% monthly interest in order to play the market are very under water, and are reacting as one might expect people to react, if those people had bet everything on a seemingly one-way ticket that turned out to be very multi-directional.
The Beijing government - whose first and foremost priority is survival - has every incentive to assuage the potential homeless thousands by supporting the market. A belief in free market capitalism is way down the totem pole for the members of the Politburo. If the government of China believes its best interests are to support the market, it certainly will. As for the argument that it is not in China's best interest to tank the dollar by dumping T-bonds, that may be true most of the time, but if the government believes it is threatened by social unrest, it will do what it has to do now and worry about the consequences later.
After all, China owns $1.2 trillion worth of dollar reserves. And if you look at Thursday's action in the Treasury market, someone was desperately selling.
That is a big, big move in the bond market.
I pondered this scenario for much of the trading session, and was told by a bond guy whom I met on the way out of the office on Thursday evening that there had been aggressive selling of agency debt, i.e. Freddie Mac and Fannie Mae, out of Asia today.
Frankly, I have no idea. But the real action was in bonds, not stocks.
Stocks, though, did not escape the slaughter, especially in some of the hot sectors. Take a look at the utilities
That is a big move for utilities.
Look at what the industrials have done.
Look at the REITs, which I am short on.
Real estate has to hold near here, baby, because we've already cut through the 200th day like it was butter. It is a long, long way down after we break that (weak) level of support at $79.
I am essentially net flat in my portfolio, with only one short relative to the rest of my equity longs. That short is my position in long dated puts on the Real Estate ETF (IYR). As I have been saying, REITs are stupid here, trading at a 40%-60% premium to stocks when they should trade at a discount. With the cost of financing going up, that is a dangerous cocktail.
Also, look at the banks.
And, look at the brokers, as well.
Neither one is really healthy.
And frankly, the proverbial canary in the coal mine, gold, doesn't thrill me either.
Weak retail comps and higher oil prices were also factors in the sell-off, but the main driver was the violent rise in interest rates.
Alas, though, there is no need to worry. Helicopter Ben will come to the rescue, I am sure. This seems to be his wont whenever asset markets get in trouble, just like his predecessor, Easy Al. It is the reflex of the Fed to bail out investors for their mistakes. No matter that spreads are at record lows in emerging and junk bond markets, the economy is too reliant on keeping asset markets afloat.
I do not think this sell-off is The Big One. Maybe it is, I don't know, but the run in stocks since July has been very methodical, not manic. I am inclined to believe there is a frothy stage yet to come. But perhaps that froth won't come to U.S. markets. It may be manifesting in emerging markets instead, as China and others have been highly speculative.
I believe this is the much awaited near-term pullback I keep yammering on about. I think we will yet see higher highs during the year. Then sometime by the end of 2008, you'll want to be far away from stocks as possible.
I don't think we're there yet. But if we are, bring it on!