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Buying Vix calls & $13 trillion Chinese bond market (Update)

This weekend we are having a few of my City friends over for three days.  I do this every three or four months just for the sheer pleasure of talking finance and investment again.  This weekend my broker and his wife, as well as Peter (aka China Peter) and his wife are staying with us.  

Two stories first that a very influential American broker has been recommending that its client buy VIX calls, the second that 80% of bonds in the Shanghai bond market are in default.

Now the VIX is a derived index, because it's an index on the volatility of the S&P500, now buying a call means you think the index is going to rise:   That stock prices are going to move more quickly and by greater margins.  Effectively, this is an instrument that allows investors to either seek protection or profit from a fall in the S&P500.  The broker is anticipating a general market correction.  The problem with that call is that the US market indicators are positive.  Buying calls or puts on the VIX are short-dated instruments, so it seems that this broker anticipates an important correction very soon.  

Second, The Shanghai bond market is a massive domestic market, which means that investors and issuers are 99% domestic, there is almost no foreign involvement in this market, and for the past 10 months, it has been forbidden to publish market data for bonds.   The reason 90% of bond issuers are provinces and municipal governments, which can only pay the interest and principal on these bonds by selling land.  According to available data, 80% of bond issuers on the Shanghai bond market are in default, they are not paying interest.  It is sufficiently prevalent for the Chinese government to issue an edict that financial institutions holding these bonds, even if they are not performing can keep them as performing assets.   

To understand the reason from the broker call you have to look at stock performance.  If you had invested  £ 100, on January 1 2009 in the S&P500, the FT100, and China SHCOMP how much would you have on January 1, 2024?   (S&P500 869 to 4,010), (FT100 4561 to 7689) (SHCOMP 1954 to 3,089).  The US S&P rose by 460%, the UK 168% and China 158%.  Arbitrary dates, but in the 15 years, the Chinese economy grew 500%, while the other only grew by 40% and 32% respectively.  

In an economy that grew by 500%, the private sector has been growing at about the same rate as the UK, which has suffered through a recession and Brexit.  The reason I mention these figures is it seems that the US S&P500 captured the benefits of China's GDP growth.  The US broker's argument for a correction is that near-shoring and on-shoring economic activity will not benefit US corporations as much, and therefore GDP growth will benefit others (workers and taxes) than US corporations.   Therefore stock prices will fall, because stock prices are a reflection of expected growth.  That's the story that the US broker is selling to its ultra-high-net-worth investors.  That on-shoring will lead to lower profits from expanding sales. Therefore stock prices will fall quickly when investors realize the changing impact of US GDP growth...

A very reasonable analysis, US corporate results for 2023 will be out very soon, buying the VIX is a very effective tool to take advantage of market uncertainty...a great call.  As for China, well they really are screwed.  

Note:  It was pointed out that selling Puts has largely the same effect as buying calls, and why they are correct, the difference is in the nature of the closing of the transaction, the call market is far deeper than the put market.  I thought I should make that point, aside from that the yield is similar.

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