A-Shares Commentary: To Equanimity And Beyond!

(Jul 13 2015) - After the dramatic developments in the political environment surrounding A-share prices in the last two weeks, the trick to dealing with A-shares in the near-term is to take a calm look at all the factors in play, and to understand what they mean.

Be equanimous!

The last two weeks have brought us an enormous amount of action by the Chinese government to stop water from going over a waterfall. Even to the point of declaring waterfalls irrational, calling forth the bucket brigade, forbidding some water from playing in the stream above (there had been hardly any short-selling, now there is a fraction of that amount, and the govt is looking for (and has found, it appears), "malicious" activity), and flash-freezing other water (lots of players are no longer "allowed" to sell). They have set up a huge pumping station next to the top of the waterfall (brokers, insurers, Central Huijin, executives, companies, etc) to force a fair bit of water (which would otherwise go over) uphill instead. They have, in one night, built an aqueduct (the CSF program to backstop brokers) to catch water as it goes over (where the aqueduct leads to, is not known - it could be an aqueduct to nowhere). They have even turned off the taps upstream (no IPOs or secondary offers).

Silly metaphors perhaps, but they may serve. Waterfalls exist in nature. This is where the support under the water no longer exists and water succumbs to gravity. Falling until it reaches another equilibrium. For people in a canoe riding the river, there is a moment of slow motion vertigo as you go over the edge, a moment of panic as it appears that there is nothing you can do, a moment of resignation as you realize there is nothing you can do except bail from the canoe, and a moment of mad churning around at the bottom until you find your head above water, and see the canoe. Some get dashed on the rocks. Some drown. Everyone gets tossed around.

Helpfully for canoeists in China, the Chinese government has decided that there will be no more waterfalls to observe. Waterfalls should not exist unless explicitly allowed.

This is the New Nature, the NEW Capitalism with Chinese Characteristics.*

For now.

CONCLUSIONS

• Equanimity as an investor is tough. Divorcing emotion from the investing process is sometimes impossible, perhaps particularly for "rational" investors facing the "irrational." But it is crucial.
• Consider what has been done and what the state of play is.
  • There are a lot of people who would have been sellers who are not. Lack of supply.
  • There are those who are buyers who would not normally be. Extra demand.
  • There are a lot of things which should be trading which are not. Lack of supply.
  • There is a lot of "normal" demand which will stay away because they don't have the money to play (people who got dashed on the rocks) or who don't want to (those who see this "New Nature" as a false market full or moral hazard which cannot be trusted). Reduced demand.
• The answer to "What Next?" is understanding the interplay of these forces and how they change over time and price space.
• There is a new rationality and it kind of looks like the old one. Up is encouraged. Down is not encouraged. Fundamentals can hang themselves.
• Near-term, it may be rational to be irrationally exuberant.
• And selling short-term puts on indices with lots of high-weight low PER large caps in them may make sense too.
• Some may decide that H-Shares are not a bad place to invest after all.
• Embrace equanimousness.

*if you haven't read Yasheng Huang's book of the same name, it is a most fascinating read.