China’s long march to stock exchange stability

There is a rich vein to mine when searching for patterns and precedents that might help explain gyrations in western markets. Those searching for plausible parallels for this year’s bounce have travelled back as far as the Panic of 1907.

History, alas, is not much help when it comes to making sense of market movements in one of the world’s most ancient civilisations. China’s stock exchange – launched by communist rulers as a grudging experiment in the early 1990s – is a mere teenager, and often acts like one. It is a confused creature, prone to hormonal highs and lows, and occasionally frustrated by parental (read government) supervision that is too permissive one month, too strict the next.

China had a stock market before “liberation”, as the Chinese Communist party likes to call its triumph in 1949, but don’t look to that chaotic era for comparisons to explain the 20 per cent fall in Shanghai’s Composite index in the fortnight to August 19, after more than doubling over the previous nine months.

In a perhaps apocryphal comment, Zhu Rongji, the acerbic former Chinese premier, supposedly groused that in the good old days – roaring Shanghai circa the 1920s and 1930s – investors who lost everything would jump off rooftops, but now they protest outside government offices.

The party’s fear of investors at the gates is instructive. For China’s rulers, a plunging stock market is about as welcome as soaring inflation or unemployment. With 700,000 accounts being opened by new investors every week this summer, it would not be hard to organise a protest rally or two.

Fears of social instability aside, longer-term policy priorities also underlie the Chinese government’s desire to see the slide arrested.

As Jing Ulrich, chairman of China equities and commodities at JPMorgan, writes in a research note, market stability is important for goals including the first Shanghai listings of offshore Chinese companies (so-called “red chips”).

There is also a raft of initial public offerings to keep afloat. After a 10-month drought, China opened the floodgates this summer. Shanghai is top of this year’s issuance table, with $9.2bn in new offerings according to Dealogic.

As a result, league table-conscious bankers at brand-name western banks have had to surrender pride of place to China International Capital Corp, the mainland investment house and world’s leading bookrunner in 2009.

Market-management tools at the Chinese government’s disposal include liquidity adjustments by the central bank, more mutual fund launches and, when Beijing really needs a sledgehammer, a reduction in stamp duty.

They have been used before. In July 2005, a four-year 55 per cent slide was arrested just as the Shanghai Composite was poised to breach the psychologically important 1,000-point barrier.

Even by China’s standards, the resulting bounce was ridiculous. The index breached 6,000 in October 2007, then fell 72 per cent in just over a year.

These booms and busts have borne little rational relation to China’s underlying economic performance in the past decade. And with overseas participation restricted to carefully controlled quotas, the Shanghai stock market remains an overwhelmingly domestic affair. All of which begs the question – why should anyone else care about the Shanghai market’s increasingly violent ups and downs?

Yet care we do. Its shock daily falls this month have been reflexively cited for sympathetic movements in markets across the globe.

The argument for caring assumes that the Chinese investing public has, against all previous evidence, developed a mature insight into the workings of the broader macroeconomy.

After first-half bank lending exceeded the official full-year target, and then fell 77 per cent month on month in July, investors have supposedly taken fright at the implications for future economic growth.

Such a scenario would indeed be worth the rest of the world worrying about, especially with regard to the potential impact on global commodity prices.

Assuming that China’s juvenile market is growing up, and has reacted rationally to what has become a less rosy economic outlook, it could bode well for investors betting that this month’s fall heralds a correction rather than a crash.

Before this month’s market fall began in earnest, Vincent Chan and Peggy Chan at Credit Suisse noted that a retreat was overdue with China stocks trading at 22.5 times forward earnings compared with their long-term average of 17.64 times.

Fraser Howie at CLSA says: “All the market had in August is a reminder that the Chinese economy is not as strong as people think. It’s just a bit of a wake-up call.”

Source:FT