QOTD: Jason Hsu on the Shanghai Bust

Research Affiliates is out with a piece looking at the bursting of the Chinese stock bubble this summer. Jason Hsu sees this event in Shanghai’s “A” shares as another example of a market properly rewarding the informed and punishing the clowns. I agree with some elements of this argument.

Here’s Jason (emphasis mine):

For every transaction there is a buyer and a seller. As the A-shares market rose, trading volume also stepped up meaningfully. Investors might have recognized the rapidly expanding amount of margin debt in the system as a sign of rampant speculation and prudently reduced their positions. No doubt, many sophisticated investors—local hedge fund managers and traders at large financial institutions— took profits as the market became more expensive and increasingly speculative. It is also common knowledge that company insiders aggressively issued new shares and unloaded their personal stakes to take advantage of what they perceived to be irrationally high prices for their stock.

Many of the buyers opposite these profit-taking sellers were naïve investors who did not properly evaluate company fundamentals or assess the investment risk of buying equity shares at three-digit P/E’s. Is it a failure of the stock market when investors who choose not to properly assess company fundamentals and investment risks are penalized or even eliminated from participation? 

Quite the contrary, a well-functioning market should chasten those who compete poorly and reward those who compete well. However, the brutal efficiency of transferring wealth from retail investors into the pockets of hedge funds and iBank proprietary desks is inconsistent with the values of many policymakers who favor economic equality. It bears mention that bubbles can also catch hedge funds, proprietary trading desks, and insiders unawares, too; it’s not just the little guy who gets crushed by the aftermath of a bubble. Nonetheless, I suggest that the Chinese bubble is not primarily an economic crisis. It is better understood as a social crisis occasioned by a massive wealth redistribution that disfavors average investors.

Harsh but fair.


The China Syndrome: Lessons from the A-Shares Bubble (Research Affiliates)