wishful investing

China’s long horizon for stock market reform means that Shanghai’s big rally today was overly optimistic

January 14, 2013
January 14, 2013

China’s stock market exploded on news that the government was considering widening the channels through which foreign investors can buy stocks, opening the door for a potential influx in demand for A-shares, as Chinese stocks are known. The remarks, which came from China Securities Regulatory Commission (CSRC) head Guo Shuqing at a conference in Hong Kong, sent the Shanghai Composite up 3.1% on Jan 14. ‘‘Our goal is to make it easier for nonresidents to issue and trade securities in the domestic markets,” said Guo, according to the New York Times. “I think at least we can increase [the stock market share held by foreign investors by] 10 times,” he added. (Foreign investors currently hold about 1.5% of China’s total stock market.)

But the jubilant market reaction seems a tad overdone given that more specifics or a timeline—or, for that matter, mention of any new policies—were all notably absent from Guo’s remarks. The market surge likely reflects relief about a gnawing problem with China’s stock market: that fewer and fewer people seem to want what it’s selling.

Take the 169 foreign investors—mainly banks, institutional investors, brokerage houses and sovereign wealth funds—that the government lets invest directly in China’s stock market at present. Last April, CSRC increased the amount of domestic securities that qualified foreign institutional investors, as they are known, could invest in Chinese stocks from $30 billion to $80 billion. But by the end of 2012, those investors had snapped up only $37.4 billion in total.

Then there’s China retail investors. The number of funded brokerage accounts fell to 55.09 million in the week ending January 4, from about 56.81 million a year ago (link in Chinese). As a percentage of total brokerage accounts, those with a balance made up only 32.8%, a historic low (in Chinese). This suggests a “hollow” rally, says Bloomberg Brief’s Michael McDonough, who provided the following chart:

Is China's appetite for A-shares dwindling?

Is China’s appetite for A-shares dwindling?

According to First Financial Daily (in Chinese), the lack of dividends among A-share companies means that stock income depends largely on playing volatility—a risky proposition for most retail investors, as their attrition likely indicates. Though the regulator has tinkered with promoting dividends, today’s remarks may suggest that, rather than trying to get retail investors to buy and hold, the Chinese authorities may be coming to see foreign investor demand as a more effective tool for reviving ailing A-shares. Meanwhile, news on Friday that the central bank is considering a pilot project that would allow domestic investors to trade on overseas capital markets—thereby diverting their demand away from A-share stocks—reinforces this impression.

But volatility and a general lack of concern for shareholder value will eventually deter many foreign investors as well. Indeed, as far as attracting foreign investors goes, the brewing battle between the US Securities Exchange Commission and CSRC—the latter refuses to let Chinese companies listed in New York disclose certain information that may be deemed “state secrets”—makes one wonder how exactly the regulator plans to deal with the transparency standards that foreign investors typically expect. Until it works out those kinks, an A-share recovery still looks to be a long way off.

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