Tag Archives: pro

Is China A Building Block In Your Portfolio?

By Ellen Law After China’s stock plunge in Q3 2015, many investors have had two different views toward China. The bearish camp avoids buying Chinese stocks, as they think the Chinese market is volatile, and that the earlier stock market bubble has not fully burst when it comes to the problems of shadow banking, margin lending, and an overheating property market. The bullish camp holds a different view, claiming that Chinese stocks are cheap now and that the panic sell-off had been exaggerated. It claims that the valuation of China is getting lower, which presents a potential buying opportunity, especially for long-term investors. No matter which view you take, either bearish or bullish on China, one cannot simply ignore China, considering its size and importance in the world economy and long-term economic growth. For this reason, it may not come as a surprise that some indices and investment products were launched for a pure play in China after the recent sell off, such as the S&P China 500, which seeks to track all Chinese share classes, including A-shares and offshore listings. Alphabet Soup of Chinese Share Classes To capture the complete Chinese story, investors may invest in different Chinese share classes. However, Chinese share classes are often seen by foreign investors as being quite complex. A-, B-, H-, L-, N-, and S-shares are just like the different letters mixed in alphabet soup. In reality, only a handful of share classes, namely A-, H-, and N-shares, represent around 99% of the total market capitalization of the Chinese equities market. A-shares are Chinese companies trading on the Shanghai and Shenzhen exchanges in renminbi. International access to these domestic shares has been limited, but they have become more open due to the market liberalization supported by the Chinese government. H-shares are similar to A-shares, but they trade on the Hong Kong Stock Exchange in Hong Kong dollars. They are open to international investors without any restriction. N-shares are Chinese companies trading on the New York Stock Exchange and NASDAQ in U.S. dollars. Some of them are fast-growing internet and technology stocks, such as Alibaba (NYSE: BABA ) and Baidu (NASDAQ: BIDU ). For the list of Chinese share classes, please refer to Exhibit 1. Liberalization of China’s A-Share Market It is worth noting that the historically restricted A-share market has now been made more readily available to international investors, and thanks to the launch of the Qualified Foreign Institutional Investor (QFII), Renminbi Qualified Foreign Institutional Investor (RQFII), and Shanghai-Hong Kong Stock Connect (Stock Connect) programs, both QFII and RQFII allow approved applicants to access to the A-share market via a quota system. The total QFII and RQFII quotas have reached $78.97 billion and RMB 419.5 billion ($66.3 billion), respectively.[1] The Stock Connect is a significant measure that links the Shanghai and Hong Kong stock exchanges, allowing mainland Chinese investors to purchase selected eligible shares listed in Hong Kong, and, at the same time, letting foreign investors (both institutional and retail) buy eligible Chinese A-shares listed in Shanghai. The Stock Connect is expected to expand to the Shenzhen stock exchange soon, since both the Hong Kong and Shenzhen bourses have said the launch preparations had been completed and were waiting regulatory approval. [1] State Administration of Foreign Exchange, data as of Oct. 29, 2015. Disclosure: © S&P Dow Jones Indices LLC 2015. Indexology® is a trademark of S&P Dow Jones Indices LLC (SPDJI). S&P® is a trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a trademark of Dow Jones Trademark Holdings LLC, and those marks have been licensed to S&P DJI. This material is reproduced with the prior written consent of S&P DJI. For more information on S&P DJI and to see our full disclaimer, visit www.spdji.com/terms-of-use .

Myopia & Market Function

Benartzi defines myopic loss aversion as making “investment decisions based on short-term losses in their portfolio, ignoring their long-term investment plan.”. Myopic loss aversion can arise when investors check their account balances or the prices of their holdings which thanks to technology has become increasingly more convenient to do. We know that there will be future bear markets and probably another crisis or two in most of our lifetimes. By Roger Nusbaum AdvisorShares ETF Strategist The Wall Street Journal posted an article written by Shlomo Benartzi who is a professor at UCLA specializing in behavioral finance. The article primarily focuses on the behavioral problems, like myopic loss aversion, that can arise when investors check their account balances or the prices of their holdings which thanks to technology has become increasingly more convenient to do. Benartzi defines myopic loss aversion as making “investment decisions based on short-term losses in their portfolio, ignoring their long-term investment plan.” Benartzi cites that the stock market has a down day 47% of the time, a down month happens 41% of the time, a down year 30% of the time and a down decade 15% of the time. We’ve talked about this before going back before the crisis albeit with some different wording. Before and during the last major decline, as well as many times since then, I’ve said that when the market does take a serious hit that it will then recover to make a new high with the variable being how long it takes. While this seems obvious now it is one of many things frequently forgotten in the heat of a large decline. Additionally we know that there will be future bear markets and probably another crisis or two in most of our lifetimes. And those future bear markets/crises will take stocks down a lot which will then be followed by a new high after some period of time. This is not a predictive comment this is simply how markets work with Japan being a possible stubborn exception that proves the rule. It took the S&P 500 five and half years to make a new nominal high after the “worst crisis since the great depression.” If you are one to use some sort of defensive strategy, it is hopefully one that you laid out when the market and your emotions were calm and your strategy probably doesn’t involve selling after a large decline. My preference is to start reducing exposure slowly as the market starts to show signs of rolling over. Very importantly though is that if you somehow miss the opportunity to reduce exposure, time will bail you out….probably. I say probably based on when a bear market starts in relation to when retirement is started. If a year after retiring, a 60% weighting to equities that cuts in half combined with a life event at the same time that requires a relatively large withdrawal (this is not uncommon) it will pose some serious obstacles. I think the best way to mitigate this is, as mentioned, a clearly laid out defensive strategy but not everyone will want to take on that level of engagement. In that case it may make sense for someone very close to retirement and having reached their number (or at least gotten close) to reduce their equity exposure. Not eliminate, but reduce. Back to the idea of myopic loss aversion and how to at least partially mitigate it. Knowing how markets work and then being able to remember how they work will hopefully provide an opportunity to prevent emotion from creeping in to process and giving in exactly as Benartzi describes.

Things Won’t Stay The Same

My kids keep growing up, and it continues to surprise me. One who was just learning to stay upright is now a constant chatterbox and a daredevil on her Strider bike. The other seems to have grown a foot this year, and has gone from quiet and reserved to confident ringleader of her friends. But the realization I’ve recently had is that it is so easy for us to assume the current state of affairs will perpetuate into the future. The little baby who was so happy to sit and play with a toy was suddenly gone, whether I was prepared for it or not. Someday soon, both of my girls will be in high school fighting over clothes and car keys. In the moment, that is hard to remember. Whether things are great and everyone in the house is sleeping and happy and playing nicely together or we’re up four times a night and separating a fight every twenty minutes, it is easy to believe that this is how things will always be. In behavioral finance, this effect is known as recency bias . It is our strong tendency to extrapolate recent events forward into the future. And investors do this all the time. I mean all the time . In March 2009, as the stock market was approaching generational lows, the most popular headlines and predictions were that the Dow Jones Industrial Average, having just passed below 7000, would continue to drop as low as 3000. And of course, the most famous example of recency bias is the book Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market . Published near the height of the stock market in 1999, when the DJIA was just above 11,000, the book was wildly wrong. But it was a perfect example of how easy it is for us to see a pattern and project it into the future. We haven’t learned much since the 2008-2009 bear market or the late ’90s tech bubble. Oil prices seem to been in a near free fall for the past few years. So guess what is being predicted? More declines! Goldman Sachs suggested that oil prices could go to $20 a barrel in September. Of course, in 2008, Goldman Sachs also predicted that prices, then over $140 a barrel, would eventually surpass $200 a barrel. Making professional predictions is fairly easy – you take the recent changes and extrapolate them into the future. Tada! And of course, it isn’t just professionals making outlandish predictions that fall prey to recency issues. Individual investors are just as bad. Emerging markets have been dismal for the past several years. Returns have been negative so far in 2015, and emerging market stocks lost money in 3 of the last 4 calendar years. In May 2015, EM stocks started a nasty slide. By September, investors assuming that the recent past would continue indefinitely had had enough, and started pulling money out of these funds. Here’s what flows out of Vanguard’s Emerging Markets ETF looked like this year. Investors love to hear and talk about what is going on in the market “right now.” We love this idea because we assume that “right now” will continue into the future. But what is true today won’t necessarily be true tomorrow. The world is a changing place, and always has been. Don’t be fooled thinking anything else.