This morning, major news outlets are stressing the fact that China’s Shanghai Composite Index slumped as much as 5.1% overnight, extending the index drop from a 2009 high to more than 20%, the common definition of a bear market.

But this volatility should not come as a surprise to investors. The basic risk-return relationship also applies in the case of China. If you want higher returns, you will have to accept more risk. And the Chinese stock market did deliver returns. Since the beginning of the year, Chinese benchmarks lead nearly every other major index around the planet.

But this performance has a price. Since 2002, the Chinese indexes are also among the most volatile. The annualized volatility reaches 33.75 in the case of the Shanghai “B” index (open to foreigners) and 27.6% for the “A” index (locals only).

In fact, it should be kept in mind that the new bear market is the sixth one since 2002. This amounts to a bear market almost every year. In the current context of highly stimulative monetary and fiscal policy, I see the current correction in Chinese equities as a consolidation rather than a reversal of fortune.

Mounir R. El-Ayari, CIM, FCSI, C.h. P. Strategic Wealth
Investment Advisor
Associate Portfolio Manager
e-mail: mounir.el-ayari@nbf.ca

When I speak of risk in regards to investing, I am speaking of volatility risk. As a portfolio manager I do not have a history of recommending companies that could potentially go bankrupt. In my Asset Allocation basket, for example, none of the companies that I have owned over the past few years have gone out of business. Given that six months ago there were numerous world class blue chip companies that were falling like trees, this is something that I am thankful that I was able to avoid. In my conversation with my client, I gave her an example why it makes sense to start slowing buying some of these high dividend yielding companies. Let’s assume we buy a company today that is trading at $30 and is yielding 5%. Let’s also assume that the market gets much worse and this company which we all recognize trades down to $15. We then buy the same amount that we bought at $30, thereby giving us and average price of $22.50. If this company continues to maintain its current dividend or even slightly reduces it, you will still be earning an attractive yield while you wait for the shares to appreciate. The worst case scenario is that the company, for the first time in its history, cuts its dividend entirely. Even if this happens don’t you think that the shares of this world class company will trade much higher in the next several years given that it has a solid balance sheet and traded in the $60 range not so long ago? I would argue the risk is worth the reward.

Mounir R. El-Ayari, CIM, FCSI, C.h. P. Strategic Wealth
Investment Advisor
Associate Portfolio Manager
e-mail: mounir.el-ayari@nbf.ca