A Bubble Bursts - Oh Well

"If you must play, decide on three things at the start; the rules of the game, the stakes and the quitting time." - Chinese proverb

"Please God, just one more bubble." - Bumper sticker in Silicon Valley 2003

Since the June 13, 2015 peak of 5,166 the Chinese stock market plunged to 3,507 on July 7 before staging a moderate recovery.  The loss of 1,659 points or more than 30% has all the signs of a bubble bursting.  Certainly at their peak Chinese stocks were far too richly valued with the average price to earnings ratio at 64.  To give you a metric for comparison, U.S. stocks normally trade with a P/E of 15 and are thought to be extremely overvalued when they reach 25.  So there was no doubt that the Chinese market was in bubble territory and I would expect that it has far further to fall as even today the average P/E for Chinese stocks is above 40 and their stock market is still up over 20% year to date and up almost 100% over the last twelve months.

This sudden plunge spooked international markets and combined with the Greek issues and the possibility of an interest rate rise it appears that the market in the United States is ready to follow suite, but while the two external shocks are bad for the locals I have little reason to believe that these events will undermine the US economic recovery.  First the fallout in Chinese stocks seems to be a local affair with the small investor taking the brunt of the fall.  Second the Greek issues are largely contained as most of the debt, assuming it is written off, sits in the central bankers coffers rather than individual banks.  Third the chances of contagion occurring throughout the Euro zone are limited as the poorer performing nations are expected to remain in the Euro and may even get their houses in order quicker once they witness the fall out effects of a Greek exit.

So while the markets here are gyrating wildly these events are not the black swan that people are waiting for (remember that a black swan event is something completely unknown so by its very nature these events cannot be black swans).  The short term results are more than likely a longer period of low interest rates and potentially a resumption of the secular gold bull market.  The Federal Reserve is under no pretenses that the global economy is weak and has been further weakened with these events.  Furthermore raising the interest rates now, as I have repeatedly blogged, would strengthen the dollar and weaken the tepid recovery in the United States right when it appears that there is finally some decent economic traction.

Whether the market recovers and shoots to new highs is any ones guess but to me a decent bet would be to buy into some of the gold mining stocks.  They have really been battered over the past few years and if the Chinese move their money from the stock market into the gold market, as is being promoted in China, it would not take a lot to tip the scales back into the gold bull camp and this would be magnified in the down trodden gold stocks.