Investors profiting from China's buoyant market must know when to stop
Andrew Sheng says in an unpredictable market, punters must know the risks and control greed
We have never before had a period quite like this, with data all over the place and the future truly murky. Abraham Lincoln said 150 years ago: "The dogmas of the quiet past are inadequate to the stormy present … As our case is new, so we must think anew, and act anew."
An uncertain future is nothing new. What is difficult to read are the five major global forces that are disrupting almost everything, from our daily lives to geopolitics: urbanisation, technology, demographics, globalisation and climate change. We sense that natural disasters are becoming more unpredictable, but are not sure whether these signal something more ominous for the long term.
With information overload, we can't sort out the signal from the noise.
The stock market carries a lot of noise - short-term fluctuations due to no news or bad news. Since governments and firms use public relations specialists to spin news, one is never sure what is fact or fiction.
Is the Chinese stock market in a bubble and is it about to burst? As a former securities regulator, I know how difficult it is for a government official to comment on the market. If you say it's too high and the market goes higher, those who believed you would say that you cost them lost opportunities to make money. If the market drops after you make that market warning, the losers claim that the government has no business interfering in the market. This is a no-win situation.
So all I could say was to repeat the four "knows" - do you know what you are buying, what risks you are taking, how much you can afford to lose, and, finally, do you know yourself?
The first question should be easy, but is very difficult because the Chinese stock market has not behaved according to normal theory. Between 2007 and 2013, when the Chinese economy was the fastest growing economy in the world, the A-share index dropped from 6,000 to a low of 1,800 in 2008 and lingered around 2,000 till August 2014. It then rebounded and, in a matter of months, reached the current level of 4,300. This happened despite the economy slowing to almost half the former speed.
The market recovered because retail investors are back in the game, punting not just on penny stocks but also highly speculative technology stocks. One real estate company changed its name to one that invoked technology and its shares went up. Technology company stocks are defying valuation logic, because many do not even make money, or may never make money.
Just because a handful may become the next Apple or Tencent does not mean every one of them will. In fact, many are likely to fail.
Knowing the risks you are taking is both a question of fact and your own financial circumstances. When you buy a speculative stock, you can win big or lose big.
With exceptionally low interest rates, it is difficult to judge valuation according to conventional methods. How do you apply discounted cash flow valuation based on near negative real interest rates to even bond prices? Even experienced fund managers are having a tough time predicting bond and equity prices, because central bank intervention through quantitative easing has changed the game.
The third question depends on your own financial circumstances. If you are a retiree or have a lot of financial commitments, it would be dangerous to bet on speculative stocks. One must have a bottom line on how much to lose.
The last question is most difficult. No one can protect you from your own greed or stupidity. The most dangerous investments are those in which you win initially and then you double up and the market reverses.
Investment requires discipline on one's own emotions. We will never be able to buy at the lowest point and sell at the peak. The key is to control your own greed and take profits when you win and cut losses when you know the market is against you.
In today's game of computerised trading, a retail investor is trading against professionals and computers. You are not even sure whether the increased volume and liquidity is due to professionals who understand the valuations more objectively or due to computers buying and selling because of an algorithm that picks stocks according to price and volume signals. All you know as a retail investor is that when the price reverses, it will do so very fast.
The market moves on valuation, momentum and sentiments of greed and fear. Valuation is tough to measure and momentum is crowd- and computer-driven. Hence, whether you win or lose really depends on your ability to control your own emotions. If you made good profits and did not take them, then you have no one to blame except yourself when the price changes.
My own rule is to trade on the noise, but invest in the signal. What is the right signal is up to individuals to assess. Enjoy the buoyancy whilst it lasts and don't be too greedy.
Andrew Sheng is a former chairman of the Hong Kong Securities and Futures Commission