There is a salutary lesson being given right now to anybody who invests in Western markets but few are paying attention. If the penny drops, things could get very ugly indeed.
Overnight, the Shanghai Composite Index fell another 8.5% - with the real damage being done in the last hour as sellers, spooked by a Bloomberg story which suggested intervention in Chinese markets may be curtailed at the behest of the IMF (who, somewhat hilariously, feel that the level of intervention from the Chinese government is a little over the top).
Was the IMF story the cause of the meltdown? Well, it's hard to see why anybody would think for a second that the Chinese would listen to the IMF about such matters (not even in the face of their desire to be admitted to the SDR), and anyway, it doesn't matter. There doesn't have to be a reason for falls like this one.
This is exactly what I wrote about in my most recent Things That Make You Go Hmmm... 'The Sum of Both Fears' (www.ttmygh.com).
Whatever the reason, the selling overwhelmed the bids of both natural buyers AND the massive interventionist forces of the PBoC and the seemingly myriad regulatory bodies.
75 stocks fell for each one that rose and those hit hardest were the stocks (such as PetroChina) which had been the recipients of state largesse in the form of direct intervention in recent weeks.
Adding to the woes was the release on Friday of Chinese Industrial Profits, which fell 0.3% YoY.
Again, nobody really believes the numbers emanating from the Chinese National Bureau of Statistics, but when markets are rising, cognitive dissonance reigns supreme.
This time, however sentiment being tilted towards fear was all it took to generate the second-largest fall in the history of the Shanghai Composite.
The lesson? Well, Chinese investors' confidence was buoyed by the explicit promises (and actions) of the Chinese State machine who directly bought stocks and, seemingly, put a cast iron bid under the market but when investors' level of nervousness reached a certain point (a point that nobody could have pinpointed in advance), everything changed and even bans on not only those 'evil short sellers' we continually hear about in the West, but selling, period, were not enough to stem the tide.
Nor were threats of arrest for short sellers.
Nor were hundreds of billions of dollars (equivalent) in direct market support.
When Fear took over, the Central Bank was powerless to react.
In the West, there are no explicit official sector stock buying programs in place. There are no threats of arrest against short sellers and there are no bans on outright selling.
Everything..... EVERYTHING..... rests on one ephemeral thing - the market's confidence in the power of Central Banks to ensure a good outcome no mater what.
Anybody paying attention to the lesson should not just be thinking about what might happen when that fragile confidence evaporates, but taking steps to ensure they don't get caught out when it does.
The problem comes in leaving such precautions a day too long...
Ask anybody who was considering selling their Chinese equities last Friday but didn't...