Stocktake: Bulls take fright in China

Has the Chinese equity bubble burst? The question is worth asking, given the extent of recent falls. Last week, China's tech-heavy ChiNext index fell into bear market territory, having declined by more than 20 per cent over the previous three weeks.

The previous week’s double- digit correction in the Shanghai Composite Index marked its worst week since 2008. Volatility is soaring, last week hitting a seven-year high.

The number of new trading accounts being opened has fallen for three consecutive weeks, bears note, while there has been much chatter regarding a broker crackdown on leveraged trading.

The question of leverage and borrowed money is especially crucial, as market gains have been driven by the explosion in margin trading over the last year.

According to analysts at Macquarie, however, recent talk of a broker crackdown is overstated.

Margin positions have actually spiked 16 per cent over the last month and the firm expects it to continue rising until September.

That suggests the madness may not yet have peaked. Stocks can suffer steep falls during the bubbliest of markets; note that the Nasdaq suffered two double-digit corrections in January 2000, only to quickly gain another 25 per cent before the bubble finally burst in March of that year.

Still, while further gains are possible, some informed investors are clearly preparing for a market top.

According to HSBC, net insider selling is averaging 80 billion yuan per month – eight times higher than last year's figures. Grantham says no bubble – yet Fabled investor Jeremy Grantham is also concerned with bubbles, but in the US rather than China.

Last week, the GMO chief repeated his warning that US stocks are edging towards bubble territory. If so, things will eventually get scary; of 28 major bubbles studied by GMO, Grantham cautioned, crashes ensued in all 28 cases.

However, Grantham’s message will resonate with bulls as well as bears. US stocks are not yet in “bubble land” and are likely to continue rising into 2016.

He dismisses the “hysteria” over interest rates, noting that stocks gained between 2004 and 2006 despite multiple rate hikes.

Why, he asked, “would a single rate hike have everyone in a fit?”

Additionally, ordinary investors, as this column has been pointing out recently, remain disinterested in stocks.

“No bubble has ever broken until individuals pour money into the market,” said Grantham.

Until the “crazy buyers” emerge, stocks are likely to continue their multi-year ascent.

Buybacks fears look overstated While ordinary investors may have steered clear of stocks during the current bull market, corporations have been enthusiastic buyers, with S&P Dow Jones indices noting last week that companies spent $144 billion on stock buybacks over the last quarter.

Buybacks have their critics. They say companies, instead of growing earnings via sustainable investment, are choosing instead to buy back shares, thereby supporting stock prices by artificially boosting earnings per share (EPS) figures.

"Share count reduction now appears to be their favourite tool for enhancing earnings", S&P's Howard Silverblatt noted last week.

More than 20 per cent of S&P 500 companies are “buying their EPS growth via buybacks”.

Additionally, companies tend to buy back stock in bull markets, when stocks are expensive.

Buybacks are now at their highest level since early 2008, a fact that makes many investors nervous.

They needn’t worry, says money manager and blogger Patrick O’Shaughnessy. His research indicates the biggest buybacks typically occur at cheaper companies that they tend to be excellent investments.

Additionally, he recommends investors look at the overall buyback yield – the amount spent on buybacks relative to the size of the overall market – rather than the aforementioned $144 billion figure.

Yields have actually declined in recent years and currently stand at just 2.1 per cent, well shy of 2008’s record high of 3.6 per cent. In 2007-08, companies were splurging on stock buybacks. That’s not the case today.

Most boring market since 1994 Who knew bull markets could be so tedious?

It has been eight weeks since the S&P 500 last saw a weekly move of 1 per cent, notes market technician Ryan Detrick, the longest such streak in 21 years.

While summer tends to be an unexciting period for traders, things have been sleepy for some time now.

The US market has not had a single 2 per cent daily move in 2015.

Now, extended trading ranges are not uncommon. Three such trading ranges, lasting almost a year each, took place in the 2004-07 bull market, while lengthy consolidation periods also occurred on a number of occasions during bull markets in the 1990s and 1980s.

However, few markets are as tedious as the current one. According to FBN Securities, the trading range over the last six months has been the ninth-narrowest in history.

In other words, the current action – or lack of it – is truly something else.