“Chinese stock markets and the Chinese economy have little to do with each other.” This was a phrase spoken by several investors that I greatly respect. I agree with that comment but give it a thought for a second. It’s more than just a great way to tell US investors to disregard last night’s Chinese selloff and avoid a trickledown here.

On the way up, the Chinese markets are heralded as a proxy for the amazing growth in their economy and yet, when it declines a more rational but still bullish commentary appears. For the past several years, financial advisors and money managers have been pushing for increased exposure to foreign stocks and especially, emerging markets to capture a portion of the dramatic growth while the US economy is not so robust. Without a doubt, China is the primary engine of that strategy and with the comment that the extreme economic growth has nothing to do with the extreme stock market appreciation - it should cause you to think. Just accept that concept as reality and then see how you would feel applying that same statement to the US economy and the US market. Can you imagine anyone saying - “US stock markets and the US economy have little to do with each other.”? It works for China but does not work here. I’ll let you decide to what degree there might be some similar truth, but overall, I doubt you’d ever hear it or believe it so easily if it was said. My takeaway from this discussion is that US investors really need to evaluate why they are so in love with buying stocks that have little to do with economic growth. I suggest that the performance chasing and fascination with growth in foreign economies have become disjointed and so have the risk / reward tradeoffs.

I said I agree with the comment that the Chinese stocks and economy are not very related. Here are a few thoughts:

The Chinese markets are represented by a few hundred stocks and the total capitalization is only $2.5 trillion  - about 10% of what is traded here. However, what it’s really worth is another story and the valuations of over 40 times earnings makes China the most expensive market in the world, by a wide margin. In January, it was only $1 trillion and people thought it was overvalued then. 100% increases in the stock market are not equivalent to 10% increases in their economy. The Chinese economy is huge and the growth rates seem not only sustainable but almost unstoppable. The government has an insatiable need to maintain the economic growth and yet they have a problem - spreading it out. A large percentage of the population, primarily the rural citizens, are still living in poverty. The image we see of China’s advancement is truly amazing and yet the income inequality between the “haves” and “have nots” is very troubling. Promoting an inflated stock market or letting it get out of hand just makes the divide even worse. However, given that Chinese investors have very few investment choices and they have very low consumption rates, it’s just a matter of supply and demand to push the market to ridiculous levels. Hearing stories of maids quitting their jobs because they were making more money trading stocks is either a myth or a very clear sign that stocks and the economy are out of touch with each other. The government cannot afford to lose touch with the masses. That has happened in the past and they cannot allow it to happen again.