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China Gets a 5-Sigma Spanking

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February 27, 2007 – Comments (0)

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China lately has been so good it's bad, and when you're bad, a reprimand may be in order. On Tuesday, Chinese investors gave stocks a big "whoa, Nelly!" Investors were reacting to a combination of things, including the Chinese government tightening the country's money supply again by increasing required bank reserves. One source also cited rumors of China imposing a capital gains tax.

Many investors (or should I say traders?) may have been sitting on pins and needles waiting for an excuse to sell, since the Chinese markets have had such a blistering run lately. As my Foolish colleagues pointed out, the Shanghai Stock Exchange index was up 134% year over year prior to the drop, and it had run 68% over the past six months. Sitting on gains like that, it's little wonder people were rushing to lock in profits.

Even though China's indices have been far more volatile than our ol' faithful Dow, S&P, and Nasdaq, the drop was a biggie. The Shanghai index has seen eight days so far this year with a single-day movement of more than 3% -- the two largest were a 4.7% gain on Jan. 15 and a 4.9% drop on Jan. 31. Comparatively, the biggest move for the Dow in 2007 prior to today didn't break the 1% barrier, and the Nasdaq's biggest single day prior to today was a drop of 1.5% on Jan. 18. If you have followed my ongoing 5-Sigma series, China's 8.8% drop did qualify for the 5-sigma title.

Trina Solar, Canadian Solar (Nasdaq: CSIQ) (which is actually based in China), China Yuchai (NYSE: CYD), and China Eastern Airline (NYSE: CEA) were among the hardest-hit China-based stocks. U.S. investment banking giants also saw some pressure from the China sell-off, as many of them have been pushing further into China to capitalize on the country's growth. Goldman Sachs (NYSE: GS) and Lehman Brothers (NYSE: LEH) were both off more than 4%.

Though China is unlikely to match the growth it had last year, the country's economy is still expected to put up double digits this year. That suggests that investing in Chinese companies will still yield excellent results. But it's buyer beware when working with stocks in China, as a heavy dose of the unexpected is standard fare in this Asian dish.

For a quick look at a number of Chinese stocks, check out the China tag in The Motley Fool's CAPS investing service.

Fool contributor Matt Koppenheffer owns shares of Goldman Sachs.

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