April is the cruellest month, wrote TS Eliot. Chinese investors may beg to differ. They found May pretty cruel. In the past month the Beijing authorities have declared war on China's two principal stock markets, rattled by alleged speculation.
This had carried the Shanghai domestic share index to gains of 55% since January, and pushed Shenzhen up 75%. By the time Beijing decided to act the two markets were on P/E ratios of nearly 50 times historical earnings. But at first Beijing's usually subtle hints had no impact on a market convinced of its own immortality.
This differed markedly from its response last December when an editorial in the Communist Party mouthpiece, The People's Daily, was sufficient to cool speculation. The article predicted a crash. The next day the market fell 10%. Local brokers referred to it as the securities industry's June 4 a reference to Tiananmen Square in 1989. But that description is more apt for the tactics employed this time round.
Beijing began its offensive on May 5 when it revised its 1996 quota for new listings, raising it from RMB billion ($1.1 billion) to RBM15 billion. This suggested a lot of companies would be forced to list, so sucking up liquidity. Since previous ipo quotas ran at around rmb5 billion the market ought to have reeled. It didn't.
On Saturday May 10 it was announced that stamp duty on buy and sell orders would be raised from 0.3% to 0.5%. The authorities expected this would dampen the markets when they opened on Monday. Rather, a record RBM39 billion poured in. About 145 shares in Shanghai and Shenzhen came close to rising by the daily 10% ceiling.
The following week news circulated that the head of China's securities regulator, the CSRC, was being moved aside for a hardliner. Whether or not it was true, hardline action followed when four top brokerages were reprimanded for past transgressions.
The country's largest brokerage, Shenyin&Wanguo, was accused by the CSRC of rigging the share price of Lujiazui Finance and Free Trade Zone last year. Fellow Shanghai-based Haitong Securities was accused of manipulating Shanghai Petrochemicals' price. Two Shenzhen-based firms were also attacked. Guangfa Securities was fined for manipulating shares in Shenzhen Nanyou Property Company.
But most surprising of all, the army-backed and previously untouchable J&A Securities was fined. Each of the firms was banned from proprietary trading. For Shenyin that meant offloading its entire portfolio of domestic shares, worth rmb1 billion.
Just as the reaction to these punitive measures was being digested, the government announced the 1997 quota for new issues. Again, this was unusual, since it had revised the 1996 quota only 10 days before. The 1997 figure was RMB30 billion. Since it was estimated that RMB5 billion of flotations was left from 1996, that left RMB35 billion of potential new issues overhanging the market.
The market was hit hard. It closed that Friday with Shanghai's composite index down 7.19%. Around 382 shares and investment funds on both exchanges came close to losing 10% of their value in one day.
But the authorities hadn't finished. The CSRC suspended trading in four companies whose shares were suspected of abnormal price movements. And over the weekend greed turned to fear.
When the market opened on Monday there was a chastened mood. There was low turnover on both exchanges with daily trading sagging to RMB14 billion. In the previous weeks it had hovered confidently around RMB40 billion. More was to follow two days later when the Securities Council of the State Council annouced state-owned firms and listed companies were forbidden from using bank loans or other funds to pursue market speculation. News agency Xinhua said violators would be fined and profits confiscated. This also coincided with the suspension of yet another stock, Shenzhen Universe Industrial. The index shed 3.94% in Shenzhen and 1.94% in Shanghai.
Why had it taken such tactics to quell the frenzy? Partly because the government is in an odd position vis-â-vis its own investors. The handover of Hong Kong and the upcoming party congress left punters convinced it could not risk the shame of a crash. So prices kept rising, with farmers allegedly selling cattle to take part.
Paradoxically, the government's greatest fear is that the market would crash of its own accord - perhaps at an embarrassing time, such as the July 1 handover in Hong Kong.
No-one doubts there was a need to put a lid on hot money. And there was good reason to ban using loans to buy equities. The state worries that this diverts funds from productive investment. Every company seems to be at it. Shenzhen Shenbao Industrial, for example, made 1996 net profits of RMB42.96 million - RMB17 million was from equity investments.
There is also a macroeconomic reason for recent rallies - too much money chasing too few assets. With inflation and interest rates falling, the banks' $800 billion of deposits are being driven into equities, where returns are higher.
Where next for speculators? Thus far the main centre of activity has been equities - the Chinese shares foreigners can't buy. But with these pricy on P/E ratios of 50, the "B" share market - on 20 - looks likely to be the next source of speculation.
"B" shares are only meant for foreign buyers. But as any broker will tell you, they are increasingly driven by Chinese buying - technically illegal. Steven Irvine