Saturday, August 22, 2015

Correction - China isn't doing so well...

The Dow Jones Industrial Average has experienced an usually excessive correction - down more than 10% from its mid-May high. It seems like much of this correction is due to slowing economic growth globally, particularly in China. As mentioned in a previous post, The Peoples Bank of China has devalued the Yuan in attempt to stimulate exports. This devaluation was a wake up call to financial markets about how bad it is China. The worse may not be over - at least according to Jim Chanos a well-known short seller that places pessimistic bets on stocks.

To sell short, Chanos sells stocks he does not own by borrowing them from someone or some institution with a promise to repay the stock loan along with some interest. This is a risky proposition. The upside of the short sale is the shorted stock will decrease in price and Chanos will buy it back at a lower price and return the shares of stock for a little bit of profit. The downside is the price of the shorted stock will increase and he will not only have to pay back the loan with a stock that is now more expensive, but he will also have to pay the accrued interest on the loan. Economic theory argues that these borrowing costs will crowd out uninformed investors leaving only those, like Chanos, that seem to have the most information about where future prices will go. I don't know how bad things are economically in China, but I do know that the Chinese short positions by Chanos provide at least a negative signal about things that might come to pass.

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