Chinese Roller Coaster Suggests Bad Times

From the International Herald Tribune (New York Times international edition) comes some interesting news concerning the continuing meltdown of the Shanghai stock Index. Other commentators have noted that mainly poor and elderly investors have put their savings in the market but are afraid to speak up "since the government knows everything". Managerial societies do occasionally give an impression of economic determinism. But reading the INTELLIGENT business press we see everywhere stories emphasizing a fear that "politics" is the real "guiding" force behind market "determinism". Here are stories of bad loans ie. about a trillion US dollars while some analysts are actually afraid to say anything against the mainland. The Shanghai index had dropped 47 percent from last October as of last Saturday. It it now sitting at 2866 points (Monday) a drop from a high point of 6082 last October. The flood of new shares derived from state companies ie. "G-shares", appears to be the result of rationalizing state assets. These were held artificially high by insulating them from the market. These can now be traded and could lose value.


It was a mantra for investors in mainland Chinese stock markets in the heady days of the boom: "The government won't let the stock market fall ahead of the Beijing Olympics."

It proved spectacularly wrong. With the Olympic Games less than two months away, the Shanghai composite index has lost about 16 percent in the last month and more than 50 percent from its peak of 6,092 in October.

Hopes of a pre-Olympic revival seem thin.

The collapse, prompted by worries of contagion spilling from the U.S. subprime loan crisis, is not unique. Among other emerging Asian markets, the benchmark index in India has fallen by about 32 percent since its high in January and the main Vietnam index by about 65 percent from its peak in October.

The government has tried cutting the stamp duty on stock trades, and there has been talk of allowing margin trading, to stimulate buying. Recently, the China Securities Regulatory Commission, the mainland market regulator, lectured fund managers on the need to consider market stability; the measures have met with scant success.

Still, though obscured by the gloom, the fact remains that the Shanghai market was one of the world's best performers last year, rising 97 percent. From its 2005 trough, following a previous blowout, the index soared 424 percent to its October peak.

It has been a wild ride for investors, who bought $100 billion of equity in almost 200 newly listed companies between May 2006, when China lifted a yearlong ban on initial public offerings, and February.

The flood of listings was a turning point for China's financial markets. For the first time, they became an important source of funds for many companies.

About 58 million trading accounts were opened by Chinese investors in 2007. About a third of these have since been closed, according to Xinhua, the official news agency, citing government statistics.

Jonathan Garner, head of global emerging markets equity strategy at Morgan Stanley, says that, despite the slide, there are hopeful signs. Emerging market exports, for example, have remained strong through the current U.S. slowdown.

"This is because you have a number of large emerging economies such as China, India, Brazil and Russia that to varying degrees have embraced market capitalism and are growing very quickly," Garner said.

Still, concern about the effect of a U.S. slowdown is only one of several negative factors in play. Others include rising inflation in mainland China and the government's tightening of credit by increasing bank reserve ratios and restricting lending, possibly affecting company earnings.

The regulatory measures to cool the economy have put pressure on mutual funds to restrict net market inflows, while an unusually cold winter, riots in Tibet and the Sichuan earthquake all have unsettled investors.

"It seemed that every time sentiment showed signs of improving, an event came along that undermined it," said Peter Alexander, the head of Z-Ben Advisors, a research firm in Shanghai.

Still, he and many analysts say that rising domestic consumption in Beijing, Shanghai and Guangzhou, as well as in many second-tier cities, should prevent the economy from being derailed by a U.S. slowdown.

Also, Alexander said, rising institutional investment should help the market. Fund managers say that between a third and half of the ownership and volume of trading on mainland markets can be attributed to institutional investors. Five years ago, trading was dominated by individual speculators.

"More buying and selling decisions are being made by fund managers and insurance companies on the back of fundamental research," Alexander said. And, other analysts noted, institutions are sitting on large piles of cash, ready to invest once confidence returns.

One of the main factors that set off the recent boom was a government decision that resolved the issue of state-owned shares that were overhanging the market. These shares in state-controlled industries were not traded but were equivalent to two-thirds of the existing market capitalization.

In 2005, China started a process of swapping these nontradable shares into tradable shares, and compensating existing shareholders for any consequent dilution of their investment. To avoid having the newly tradable shares, called G-shares, hit the market simultaneously, many were subject to a lock-up period, during which they could not be sold.

Now, the lock-up period is coming to an end and investors again fear that prices could be depressed further by a flood of G-shares onto the market.

Many analysts, including Alexander, say those fears are unfounded.

Rather than selling and losing control of their companies, the holders of G-shares are using them to acquire competitors through mergers and acquisitions, he said. Not only does this make companies more competitive, it makes them more appealing to institutional shareholders, who prefer to buy into larger companies.