With the recent declines in the stock market, I was reminded of this article I read in the WSJ journal written on May 14, 2015: Chinese Investors Are Staying on the Risky Margins
The article explained how “China’s rocking stock market has encouraged typically conservative investors to embrace leverage. They are borrowing money to buy stocks and ride a rally that has seen the Shanghai Composite Index more than double in a year.”
The article was written just 3 weeks before the Shanghai index peaked. The chart below shows how the index doubled in less than a year before erasing the majority of those gains in just 7 months. You can also see how margin debt went up over 5-fold before the market peaked.
Source: WSJ, StockCharts.com
The most striking part of the article was the story of one Chinese trader:
“Kevin Zhang, formerly a senior manager at a state-owned company in Shenzhen, started with a five million yuan ($800,000) stock portfolio last year. He borrowed an additional 10 million yuan from his broker, and the value of his initial investment doubled in a year.
But he isn’t satisfied. At a dinner for big investors arranged by his broker, Mr. Zhang found that several of them made 10 or 20 times their initial investment last year. These people had borrowed money from other channels, such as umbrella trusts, now banned, that allowed people to borrow up to 10 times their investment money.
This year, Mr. Zhang gave up his stable job, with an annual salary of a million yuan, to be a full-time investor. Work wasn’t that busy at the state company, but it got in the way of trading. He says he came out of a meeting one day and found he had lost a year’s salary in an hour, so he decided he should focus on investments.
Mr. Zhang knows the market looks bubbly. The price-to-earnings ratio of stocks on Shenzhen’s growth enterprise board is close to 100 times. But he believes the government is keen for the bull market to continue. “I’m going to leave the market after I double my money again,” he said. “That will be enough for me to live the life I want to live.”
Again, this was just 3 weeks before the Chinese stock market peaked.
This is a classic example of how our emotions kill us in the markets. Too many people get lured by the prospect of rapid gains that they take absurd levels of risk, often at precisely the wrong times. Only a disciplined, systematic approach with a long-term mindset wins in the markets. Warren Buffet has a great quote: “The stock market is a device for transferring wealth from the impatient to the patient.” I couldn’t have said it better.