Its not China, its the Economy (Stupid!)

NOTE:  This Market Commentary alert was originally emailed to subscribers at Ritholtz Research & Analytics on Tues 2/27/2007 11:15 am;

This is posted here not as investing advice, but
rather as an example of a trading call for potential subscribers. We
expect to post future advisories in a similar manner — after the call,
but in the correct chronological location on the blog.


The consensus seems to be that "pressures by a big drop in the Chinese stock
market" is behind today’s market plunge. The Shanghai’s Composite Index
plummeted 9%, widely described as the "biggest decline in a decade." 

Getting the blame? "Efforts by investors to cash in on big gains and
avoid any government attempts to cool the markets."
As a reminder, the Fed
did not attempt to do the same in 1999 / 2000.

Now, why the drop in China’s benchmark stock index on fears of increased
margin requirements should impact the US or Europe is food for thought. 

Quite frankly, I don’t believe its that.

What’s more likely is the growing recognition that inflation remains
"worrisome," that growth is slowing, and that the sub-prime mortgage housing 
debacle will no longer remained "contained."

The market is fortunate that sentiment levels are only frothy, and not
completely exuberant. Also potentially containing this pullback: The support
levels for the Nasdaq 100 remain steady.

Two recent research pieces discuss these elements in detail: Our Sentiment Review, and the most recent update of the Nasdaq 100 Composite.

Both research pieces can be found at the site here.


Source: WSJ

UPDATE: February 27, 2007 12:30pm

Consider the following headlines, dominated by today’s news:

Freddie Mac to Tighten Subprime Rules (2.27)

See also: Video: Freddie Mac chairman and CEO Richard Syron discusses new subprime mortgage standards, which will be implemented September 2007.

Orders for Durable Goods Tumble  (2.27)
A key barometer of business-equipment spending — orders for nondefense
capital goods excluding aircraft — fell by 6.0%, after increasing 3.6%
in December.

No Worries: Banks Keeping Less Money in Reserve (2.27)
Every Dollar Set Aside Can Cut Into Profits

Subprime Game’s Reckoning Day (2.27)
Risky Lending Fallout Threatens to Spread;
Uncertain ARM Strength

Home Lenders Cut the Flow of Risky Loans (2.26)
Default Fears Drain Subprime Pool, Adding To Pressures on Prices 

Mortgage Hot Potatoes (2.15)
Banks Try to Return High-Risk Loans To the Originators

Default Jitters Batter Shares of Home Lenders (2.9)
Risky Mortgages Spark Concerns, Uncertainty About Fallout on Bonds


If you want to believe that some bureaucrat in China changing the margin requirements for local speculators as the cause of the US selloff, then go ahead.

Me? I prefer to believe what is right before my eyes: Decaying economic fundamentals, a complacent market that is overbought and way overdue for a correction. Add to that the single biggest positive contributor to the economy over the past 4 years – Housing – showing no signs of being anywhere near a bottom. A few more jiggles on the screen, and we there will be significant technical deterioration.

China? Yeah, I guess its China . . .

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What's been said:

Discussions found on the web:
  1. Ryan commented on Feb 27

    Perhaps the Chinese market declined because of a belief that the US economy is slowing and their exports will slow with it

  2. konaman commented on Feb 27

    straw poll on who will be the first sell sider to come out with note: BUYING OPPORTUNITY…

  3. Charleston real estate blog commented on Feb 27

    Personally, I’ve been amazed the stock market has been going up despite all the available news. A nice day for bonds, good for housing :) as long as you have good credit and can document it.

  4. Josh commented on Feb 27

    Nice call. The only thing I didn’t see was something about the Yen and the carry trade.

  5. Jim commented on Feb 27

    who will be the first sell sider to come out with note: BUYING OPPORTUNITY…

    My vote = Larry Kudlow

  6. dblwyo commented on Feb 27

    Barry – excellent quick post. In the spirt of completeness you could/should mention that existing home sales were up MoverM. :). Ahem…of course they were down YoverY by about 4.3% (relying as always on our friend CalculatedRisk). Which makes the point in support of your thesis that looking beneath the headlines at the actual data and the structural trends is well worthwhile. Given that prices. Given that prices also fell while inventories rose, well….it looks to me as if the housing implosion is just getting started but the denial(s) are beginning to waver.

    Forgive me if this is excess schadenfreude. When the market recovers tomorrow I’ll give it back.

  7. Richard commented on Feb 27

    barry i’ve been hearing that line for years now. sure it’s possible people finally woke up to the ‘realities’ of today’s global climate but it’s too premature IMO to make that statement. we’ll have to see what the follow up looks like.

  8. dark1p commented on Feb 27

    At some point, the psychology turns and the glass is semi-suddenly half empty to a lot of people. Amazing thing, the herd instinct.

    And a big tip o’ the hat to Doug Kass.

    Bob Prechter is looking pretty good today, too.

    Hey, so is Marcin.

    Now, there’s a grouping you don’t see every day.

  9. Nikki commented on Feb 27

    Can someone explain this to me?
    From CNNMoney:
    “NEW YORK (Reuters) — U.S. short-term interest rate future traders sharply raised their odds Tuesday that the Federal Reserve will cut interest rate cuts this year.

    The heightened chance of a rate cut was linked to a perception that investment risk is rising, heightened by a global equity market selloff sparked by a plunge in China’s market and weak U.S. economic data.”

    So why does increased risk and an equity selloff increase the risk of a cut? Was soaring equity markets a reason for a potential rate hike? Or are people looking for any reason to keep the punch bowl out and party going with cheap money?

  10. Si commented on Feb 27

    Well in Nikki, I believe Cramer has been waffling on about a rate cut too as well as a few others who can’t stand the sight of a bit of red. I’d love to inhabit the world these guys live in.

  11. Bob A commented on Feb 27

    Yes Kudlow is on right now telling everyone why it is such a good thing that they lost so much money today…

  12. Bob A commented on Feb 27

    Oh and does anyone remember a certain someone name George taking a victory walk on the floor of the NYSE just the other day?

  13. GerryL commented on Feb 27

    I have been watching CNBC and everyone seems to think that this is just a short term correction and of course a buying opportunity. I was really impressed how calm these people were when the Dow was down over 500 points. The consensus seems to feel this will last a few days.

    I feel so much better now. I actually thought this was a bad thing until these people convinced me otherwise.

  14. Cherry commented on Feb 27

    In the spirt of completeness you could/should mention that existing home sales were up MoverM. :). Ahem…of course they were down YoverY by about 4.3% (relying as always on our friend CalculatedRisk). Which makes the point in support of your thesis that looking beneath the headlines at the actual data and the structural trends is well worthwhile. Given that prices. Given that prices also fell while inventories rose, well….it looks to me as if the housing implosion is just getting started but the denial(s) are beginning to waver.

    Existing home sales(much like the census boards “new home sales”) don’t describe the massive cancellation “bust” we have seen out of this housing cycle. IMO, their data simply can’t handle it, nor was it ever meant to.

    I have new home sales for example, close to .850 after cancellations. A big difference from the census boards numbers, but they are behind the 8 ball due to a historic boom that was argueably, the greatest ever.

    I suspect home sales will fall in February, maybe fall alot. But that doesn’t mean it was a big decrease from the previous months, it probably wasn’t(after cancellations). The bust is a slow steady decline.

  15. Yorkd commented on Feb 27

    Do you know what happened to the DJIA at 3:00pm EST … when the graph looks like it fell off the table? How many shares were traded during the minutes around 3 o’clock? The graph that I’m viewing could be wrong, but the spike in volume looks significant.

  16. Craig commented on Feb 27

    Because the sell off is a result of a slowing econ. (See Greenspans statement) To counter the slowing econ. the fed will need to cut rates.

    If the econ were stronger, the fed would need to raise rates to counter/slow the econ.

    The argument has been between those who think it’s strong (Kudlow) and those who know it’s slowing (everyone else).

    NOW we know the answer.

    It’s now really hard to argue Goldilocks hasn’t been mugged and had her porridge (sp?) dumped on her head.
    Poor Larry.

  17. enrico commented on Feb 27


    The market doesnt seem to agree with your “growing recognition that inflation remains worrisome”.
    Bonds up huge today in an usual pavlonian fly to quality (?) way of dealing with this sort of panicking days.
    And gold down 20$ and something.
    Looks to me this exactly what you would have expected to happen as soon as the very last buyer had bought: there were no sellers on the way up, there was no bidders today on the way down. Typical.

    So to me the really wrong action today (so i agree with you on this) is in the bond market.
    Something’s gotta give. And this looks like its just the beginning of something.
    But until the bond market reacts in this way, we’re not anywhere near to going in the “inflation fear” direction.

  18. Cheney commented on Feb 27

    I agree it’s not China… blame Iran.

  19. lewis commented on Feb 27

    I feel your pain Nikki. Back in old school economics, when you ran the printing presses overtime it simply produced cheap money that drove inflation and interest rates up. Under the new improved economics (based on the physics of money being thrown from Ben’s helicopter and landing in China), you print more of the stuff up and interest rates go down, cause after it lands in China it all goes back to the Treasury, driving down interest rates. Some of us older codgers are scratching are heads are wondering how long this little trick can work, but so far so good.

    From another old codger today, Kellner – “Here is the rub: if the Fed slows money growth enough to starve inflation, short-term interest rates will rise further, thereby exacerbating the decline in housing. If the Fed does nothing to rein in the money supply, it will have a credibility problem when it comes to inflation and long-term rates will soar. ”

    So you might wonder if we are starting the printing presses up yet again, why is everyone anticipating lower rates all around?

    But that is just us old codgers talking, to put it more simply for the younger crowd, in answer to your very last question, “YES, THANKS AGAIN BEN, LETS PARTY ON!!!!
    The next round of irrational exuberence and cheap money is on Ben.”

  20. Cherry commented on Feb 27

    Bonds up huge today

    For now, they are up. But as the dollar falls and the fed cuts with the economy contracting, they could spring upward.

    You have to also remember, they are pricing in a recession right now IMO, thus the sign of the inverted yield.

    Very possible when the Fed begins to cut and the economy contracts, they reverse positions. If the carrytrade falls apart, maybe a VERY steep yield by next year.

    The flight to saftey with bonds may be short.

  21. Si commented on Feb 27

    (lewis)-Under the new improved economics (based on the physics of money being thrown from Ben’s helicopter and landing in China)…….LOL

  22. CDizzle commented on Feb 27

    I agree with Enrico’s thoughts regarding “everything” being down.

    IMHO, Fed’s mindset leads to cut rates to “tell us” that it’s all going to be OK. After 9/11, we only had 4-6 excessive rate cuts to reiterate the point that it was all going to be OK.

    Today’s price movement was a matter of time. The more things went up slowly but surely, the more that they were going to correct more “efficiently”.

    Funny thing to me is that of the 80-100 stocks on my permanent stock screener that a little company that sells private mortgage insurance (NYSE:PMI) was the best performing, only down .05%. You mean no more 90-100% mortgages?

    -still short BBY…sold the LEN puts-

  23. Nikki commented on Feb 27

    What I’m saying is that it’s really sad that our economy is seemingly on such shaky footing that a 3% giveback after a monster 9 month rally and no volatility, everyone is screaming rate cut rate cut! It just seems to me that bulls are grabbing every piece of news as a reason for the Fed to make money cheaper, regardless of the strength of the dollar and foreign investment. Not to mention core inflation, which is still not receding at the rate the Fed wants, and they’ve said so explicitly recently.

  24. ac commented on Feb 27

    Rate cuts won’t work this time either IMO. All it will do is crush the dollar and send financials tanking.

    If Business investment is going to go through a 2001 type correction, a recession is a sure thing. No doubt, no debate. The dollar plummets, other countries dollar holdings get nasty. Interest rates won’t save this economy, only a correction will.

  25. Rick Hanley commented on Feb 27

    Lennar demands 20% reductions from Contractors

    National Builder Reneges on Contracts, Threatens Trades [GTQBKYN]

    IRVINE, Calif., Feb. 27 /PRNewswire/ — Throughout Southern California, various trade contractors working on building projects with Lennar Corporation have received letters from the builder directing subcontractors to reduce and resubmit invoices for previously contracted work. Within the letters, Lennar threatens the contractors with being shut out of future work unless they meet the company’s demand to lower prices for work in progress and, in some cases, already completed. The January letters offer “trade partners” the option of lowering their previously arranged prices or “be excluded from bidding future work for a minimum of 6 months.” According to Beth Curran, executive director of the California Professional Association of Specialty Contractors, Orange County/Inland Empire (CALPASC OCIE), this amounts to extortion and sets a dangerous precedent.
    Many of the Lennar letters CALPASC OCIE trade contractors received asked for up to a 20 percent reduction in contract prices after work had commenced and stated Lennar could cancel current contracts, halt scheduled work starts or send jobs out to be rebid. Recipients were instructed to agree to the new terms, sign and return the letters.

  26. Brian commented on Feb 27

    The Dick Syron (Freddie Mac CEO) comments on CNBC are must see TV. If you want to understand why the subprime problem came about, this video makes it perfectly clear. With leadership like this, it’s amazing things aren’t worse.…90318004&play=1

    Here’s the key exchange (paraphrasing) “Q: Aren’t you a little late to the party with these changes to subprime guidelines? A: These loans weren’t a problem until recently. When short term interest rates were low and house prices were going up by more than 5% a year, even if the subprime borrower had to pay 5 points to refi, he still came out ahead. It’s only lately that these loans have had problems.”

    So in other words, if everything went perfectly (unsustainably low rates, house prices going up as far as the eye could see) they might be able to refi. This is banking? This is prudent lending? Where is the adult supervision?

  27. jkw commented on Feb 27


    The real question is why did DJI wait so long to fall. The futures had been down for 10-20 minutes already. The futures were 200 points below the cash market for a while. I thought my broker was giving me bad quotes on djx, but it seems like they were the quotes really being provided.

  28. alex commented on Feb 27

    It’s not China, nor the subprime lenders, it’s Cheney – read “The New Yorker”. US airforce is now ready to attack Iran within 24 hours if GWB or his master, Cheney decide to do so. Scary, scary…March is soon.

  29. Michael C. commented on Feb 27

    alex said US airforce is now ready to attack Iran within 24 hours if GWB or his master, Cheney decide to do so.

    The sheriff’s department is ready to haul my ass to jail if my wife calls 911 for wife beating, but that’s not likely to happen.

  30. GRL commented on Feb 27

    Not to argue that the above analysis of U.S. findamentals is wrong, but actually, I think it’s China.

    Chinese capital flight has been a major prop to the U.S. market, as discussed last year, here:

    (subscription required)

    In the past generation, when Asian economies went into meltdown — Japan in 1989-1990 and Southeast Asia in 1997 — the vast bulk of the cash flowed into the United States. Both times the end results included capital crunches in Asia and the developing world and a capital surplus in the United States. While Asia’s systems creaked and crumbled, the United States enjoyed unnaturally low interest rates and a stock market boom.

    If Chinese troubles intensify as we expect in the third quarter, the United States could actually head off its slowdown even as the rest of the world has to learn to do without much (Japanese) cash.

    To the extent that China now has to repatriate capital to meet margin calls at home, I could certainly see how that might smack down the U.S. market.

  31. greg0658 commented on Feb 27

    Ben should keep rates or raise a them a quarter … this should remove Wall Street trading volitity and make savings accounts worth having … but you traders would have to go get a real job making something … in a service economy thats a problem … why don’t you all get together and invent a company that makes widgets and hire in America please, then we’ll have money to buy your widget

    ps – a widget is something brand new that everyone wants and can afford

  32. Roger Nusbaum commented on Feb 27


    Your line about some bureaucrat in China is great.

    I do not question you thoughts about the economy or what the above indicators portend for the future but I would ask that given how rare it is for a decline of this magnitude to happen just on fundamental issues and not some sort of specific news catalyst; is it possible that the tipping point was China and whatever happens next will be about fundamentals?

  33. York commented on Feb 27

    I asked the question earlier (around 4:16 EST) about the weird market drop and volume spike on the NYSE — apparently no one here either noticed (or were concerned about) the funny jiggle. In case anyone now cares — here’s the WSJ article on the NYSE “tabulation delay” —

    This is a very serious problem.

  34. Bluzer commented on Feb 27

    “whatever happens next will be about fundamentals?”

    Guess its possible. There’s a first time for everything.

  35. pirea commented on Feb 27

    I saw that drop, I have heard about glitch. In my opinion this is the way the things are done nowadays to save the situation. When they saw 200 points drop in two minutes, they created the glitch to save the day. Remember there are millions of transactions electronic triggered at some levels. Without this glitch you could see the real disaster. I bet was even some money infusion in the system. Other way how you can explain the increase of the index and the high volume.

  36. Yorkd commented on Feb 27


    Sorry, I missed your earlier comment — “The real question is why did DJI wait so long to fall. The futures had been down for 10-20 minutes already.”

    Thank goodness that a futures market exists that can show investors where the underlying stocks are “actually” priced.

    Ironically, the SEC is now pushing something that it calls “Interactive Data”. According to the SEC, “put simply, interactive data means using technology to provide investors with quicker access to the information they want, in a format they can most easily use.” ~ (Source:

    The “interactive data” idea is good. Although they’re currently limiting the talks to historical corporate financial data, perhaps they should include accurate real-time stock prices and volumes.

    I wonder if the question is being asked, “who’s responsible at the regulatory agency(s) to monitor the failsafe systems that deal with stresses on our capital market infrastructures? And, more importantly, are they able to detect faulty risk management system(s)? Shouldn’t the the structure be capable of withstanding a 100-fold volume tsumani?

  37. Clyde commented on Feb 27

    Brian (and Barry),

    I was stunned by the lack of sophistication in Styron’s performance. Maybe the Democratic win has made him complacent. He came off as a cavalier gunslinger hedgie this morning instead of a former central banker negotiating his way through legislative oversight hearings. Maybe buying bonds backed by loans made to people that cannot afford them turns your mind into ricotta cheese. Or is it not filing timely financials? I forget which.

  38. Yorkd commented on Feb 27


    “When they saw 200 points drop in two minutes, they created the glitch to save the day”

    That’s interesting. Wouldn’t that type of action hurt the little guys who didn’t know the true market level?

  39. Brian commented on Feb 27

    Let me do some postulation on “high volume” and the “glitch.”

    I am a software developer and currently in the job market :( I have been seeing a lot of listings from financial companies looking for people to come on to their teams developing their trading platforms. Pretty much standard in all these listings are the requirement of “real time” programming experience, but they also are requiring IP networking/messaging and Windows-based programming experience.

    Given my experience with real time systems in another industry, I know just from the job listing that these companies are developing trading systems that they THINK are real time systems, but are actually not. They will work just like a real time system right up until “high volume” crosses a certain threshold and then they will melt down.

    Allow me to explain. A real time system is one in which every single operation is guaranteed to be completed within a certain amount of time. To be able to make such guarantees, your operating system must be designed with this in mind. Off-the-shelf Windows, Macintosh, UNIX, Linux does not work this way – and for good reason! I’m not aware of any way to turn Windows into a true real-time operating system, but I do know that many vendors simply add processing power and claim real-time operation. This is likely what happened with these trading firms.

    Next, IP networking. The internet. 99% of it is run using the IP protocol, which means that on any given network one 1 single computer may “talk” at a time. There is nothing around that says it’s your turn to “talk,” so a computer will just do so whenever it needs to. If two or more computers do so at the same time, they all recognize this fact (called a collision) and stop. All of them then wait for a random amount of time and try again. This works really well in the real world, except when network traffic starts getting past, oh, say 50% of the theoretical capacity of the network. Once you start approaching 70%, the network gets very close to being useless.

    Putting it together… Each time a Windows computer receives something over the internet, the network card initiates an interrupt, which does exactly that – the computer stops what it’s doing and processes the information. As your traffic increases, your interrupts increase and your “real time” system starts finishing tasks late. And to make matters worse, now all the requests you’re making to the outside world over the internet are taking much longer to execute.

    If you’ve built your trading system to react to certain events within a certain amount of time and you make the assumption that it will always get done within a certain amount of time, you probably haven’t tested for the worst case scenario or the perfect storm. And that can definitely trigger a “glitch”.

    So, there you go, my analysis based entirely upon what I have been seeing as job requirements for a lot of openings at trading firms combined with my experience in the obscure world of real time software development.

  40. Philippe commented on Feb 27

    May I suggest readers to go and see a very very good movie for further explanations of the market.
    “Wag the Dog” is a 1997 film starring Dustin Hoffman, Robert De Niro

  41. Yorkd commented on Feb 27

    I now see that my earlier comments were misguided — sorry. The problem wasn’t at the NYSE. Individual stock prices were NOT delayed, just the computation of the average by Dow Jones. The only investors who would have been hurt would have been those trading baskets of the 30 Dow Jones stocks, not traders buying or selling the individual stocks underlying the DJI. Again, sorry for the earlier worthless commenting.

  42. The Left Coaster commented on Feb 28

    Open Thread

    Was it a problem with China’s stock market that caused the US stock market drop today? Barry Ritholtz says no. Your turn now….

  43. jopo commented on Feb 28

    was it china?
    i don’t recall anyone in the msm reporting that in the 10 trading days preceding chinese lunar new year and prior to yesterdays sell-off, the shenzhen composite had rallied approx. 25% from a low on feb. 6th. think josh has touched on it, unwind the carry trade and that huge sucking sound is liquidity being taken out of the global financial system. remember what preceded last year’s sell-off? you may have guessed…the boj formally ending zirp. this may have only been a taste of what’s to come…..

  44. PrahaPartizan commented on Feb 28

    Can the Fed really afford to cut the Fed rate given the weakness of the US dollar? If the Fed starts slashing the rate, the dollar’s plummet will just accelerate, pushing inflation higher still. They really are caught in a squeeze this time.

  45. China Law Blog commented on Feb 28

    I agree with you that it isn’t China, but at the same time, I fear more to come out of China once people really get hip to the lack of transparency in the public companies there. At that point, it again will not really be China, but that will not stop various markets from plunging.

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