Monday Mandarin Market Meltdown

The Shanghai Composite fell 6.7% this morning!

I mentioned our love of FXP (ultra-short China) in our August Market Review and the short sale of FXP puts (a bullish play) was our primary cover in the last $100KP since early August for exactly the reason we are seeing play out today.  Of course China's problems were my theme on Friday and on 8/16 we warned that China's GDP wasn't real and on 8/7 we pointed out that China's 2009 growth was nothing more than an accounting trick after my August 6th article in which I pointed out that GS was desperately working to pump China up at the top (likely while they were dumping their own shares on unsuspecting suckers).  Do fundamentals matter?  Sure they do — evenutally.  But we had to roll and DD our August FXP short puts (big winners now) as it always pays to remember the words of John Keynes: "The market can stay irrational longer than you can remain solvent."

We nailed the move in the Shanghai, which is now down 25% since we turned negative on it but the Hang Seng, which is much easier to manipulate as it's controlled by foreign IBanks (our beloved gang of 12), has mysteriously flatlined near their August highs, maintaining the myth of the Chinese recovery so Uncle Rupert could run his almost daily articles telling you how great the global economy is on the other side of the world, where you can't see it.  Interestingly, in China he's running stories telling them how the US economy is leading the way back and in Europe he has total control of the media so whatever he wants to tell them is the truth anyway. 

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Ler's see how rational the markets get as mainland China falls to it's lowest level since May and let's keep in mind that "limit down" on the Shanghai is 10% so a 6.7% drop in one day indicates that scores of companies were likely halted at 10% down.  It's going to take some really big plate spinning by GS et al (already attempred by GS last night with this idiotic release calling China a "bright spot" and raising outlook 50%) to get this one back on track.  As I keep saying – the one thing "THEY" can't fight is a volume sell-off, that is just beyond their physical ability to manipulate so we'll be keeping a close eye on market volumes to see to what extent the US markets are likely to participate in a correction. 

Concerns about a glut of Chinese stocks come as investors have become increasingly worried that Chinese banks are turning off the gusher of credit opened earlier this year to help jump-start the economy. Much of that credit is believed to have found its way into the stock market, powering a furious 103% rebound in the Shanghai index from its low in November 2008 through early August.  The market's swoon since then "confirms speculation that bank liquidity had been going into the stock market," says Citigroup head of China research Lan Xue. She says the market's retrenchment will likely force some of the planned stock offerings to be delayed.

The August decline possibly signals a realization that while China's economy is recovering before the rest of the world, it is not going to reach the same heady, export-led growth rates as in years past.  "People have it in their heads that the conditions of the boom years are normal, " said Arthur Kroeber, managing director of Dragonomics Research & Advisory. "It will take a while for people to readjust to the new reality." 

Another reality people need to adjust to is the reality of the global markets.  China cannot "decouple" from the US and save the universe much as your tire can't decouple from your car to avoid an accident.  Unless you turn the wheel and get the whole car moving together, that wall you hit is going to hurt either way!  China and India, which account for roughly 40% of the world’s population, consumed about $2.5 trillion of goods and services.  The US, with 4.5% of the world's population has $10Tn of consumer spending.  A 10% drop in US consumption would need to be offset by a 40% increase in China and India's consumption – it's not going to happen folks!  Just this weekend, in Member chat, our main topic was dead and dying malls (anecdotes by members) and poor retail sales.  China can't keep manufacturing goods if no one is buying them – Economics 101.

My favorite article of the weekend that was ignored by Mr. Murdoch, his oil-pumping friends at CNBC and most of the MSM (who collect a lot of money from oil advertisiong) is a report that China has put foreign banks on notice that Chinese State-Owned Enterprises my UNILATERALLY terminate derivative contracts that provide over-the-counter commodity hedging services.  It did not name the banks or the firms in question but cited a SASAC official as saying that almost every SOE involved in foreign exchange or trade had some exposure to derivatives such as crude oil, non-ferrous metals, agricultural commodities, iron ore and coal, although only 31 SOEs were licensed to do so.  Remember all that copper stockpiling we said would come back to  bite traders in the ass?  Time to cover boys!  

Of course, you can't blame Chinese investors, those poor bastards are having a Financial Forum on September 23rd and being presented to them as a Keynote speaker on the global economy, right up there with Bill Clinton and Desmond Tutu is everybody's favorite moose hunter, Sarah Palin, who will "enlighten" the masses at what is called: "Asia’s premier investment conference."  Palin – who’s never been to East Asia and isn’t exactly famous for her mastery of public speaking or her expertise in finance and international affairs, will address 1,300 global fund managers from 32 countries, representing more than $10 trillion in funds under management.  CLSA spokeswoman Simone Wheeler says that orators at the forum often come from outside the securities industry. “Our keynote speakers are always notable luminaries."

Speaking of losing politicians in Asia – Japan's ruling party was shown the door this weekend in a landslide defeat after almost 50 years in charge.  The DJP (Democratic Japan Party) is big on stimulus, wants to fight global warming and increase Japan's military role in the UN.  "For now, the highest priority in conducting policy is to make sure the nation exits completely from the economic crisis," said Mr. Mitarai, head of the Japan Business Federation, or Nippon Keidanren, a business lobby.  "We need to see changes," said Kunio Takahashi, 65, who backed the DPJ. "Although we still don't know how it will turn out, it's better that a different party will try to change our government." 

Consumer prices in Europe fell another 0.2% in August despite rising energy costs and Germany's Conservative Party took heavy losses in regional elections against the left-leaning Social Democrats with a month to go before the general election.  Sunday's elections were a triumph for the Left party, an alliance between the heirs of East Germany's former ruling Communists and radical leftists from Germany's West. The Left's popular leader, former Finance Minister Oskar Lafontaine, helped the party win more than 21% of the vote in Saarland, his home state, and beat the Social Democrats in Thuringia and Saxony.

EU markets are trading down about a point ahead of the US open with the FTSE closed today for a holiday.  That gives us an interesting dynamic because, if we close lower than Asia probably follows through to the downside and then the FTSE, who normally lead the EU markets, will open trying to catch up to the downside tomorrow so things can get really ugly tomorrow if we can't hold our levels in today's trading. 

We're still looking to see how our upper levels hold up:  Dow 9,400, S&P 1,010, Nasdaq 2,000, NYSE 6,600 and Russell 575 and below that is another 2.5% drop, back to 9,100 on the Dow and 984 on the S&P.  That would be back to the top of our expected range and a positive test there could still lead us to raise our mid-point so let's keep an open mind.  As I said in my "Rangeish" article, it's not that I'm long-term bearish, I just felt we had risen to far, too fast and a little correction is just what the markets need.   We are 100% prepared for this drop and now we can just sit back like we have front-row seats at a concert and just see what happens next. 

There were big merger deals announced today by BHI and DIS, both of which make for nice buying opportunities in those companies as they are very good purchases.  DIS stole MRVL and we'll be buying them at the bell ($26.30) and working into a buy/write later.