In most normal markets, when enough investors acknowledge the existence of a bubble, it will burst, so why has China’s ‘A’ share market, arguably the world’s most obvious stock market bubble, not popped yet?
The short answer is, of course, that China is not a normal market. Understanding what is going on in what has already become the region’s third-largest stock market, as well as what is likely to happen, requires a deeper understanding of the structural problems within China’s financial system.
Most headlines focus on the deluge of retail money that has poured into the ‘A’ share market since the authorities initiated their structural reforms. It is easy to be blinded by this spectacle: queues of frantic punters outside brokerages clamouring to open trading accounts and play the market make for good copy, but it is still little more than a sideshow.
Data are difficult to come by in China. However, according to research undertaken by Fraser Howie, head of structured products at CLSA and co-author of Privatizing China, of the freely tradable ‘A’ shares (about one-third of the total), institutional type funds account for perhaps 25%, with retail holding perhaps another 15%. The balance of tradable ‘A’ shares is held by an agglomeration of various government-related entities and politically connected investors, accounting for as much as 60% of the total. The identity and motivation behind many of these investors and institutions is decidedly unclear.
What is clear is that combined with the two-thirds of ‘A’ shares that are subject to trading restrictions, it is the government that controls the market. Retail investors, for all their activity, add little more than froth.
China’s domestic stock markets are not just abnormal in terms of investor base: by any international measure, they are as stunted in size as they are misrepresentative of their economy. According to UBS, the free float in China’s domestic stock markets accounts for just 20% of GDP. Even including all shares held by the government at present values, the markets barely reach 60% of GDP. Most developed markets in Asia have stock market values in excess of 100% of GDP. And despite the retail frenzy in stock investing, UBS calculates that equities account for just 11% of domestic financial wealth at current levels, a significant increase, granted, from the 2005 level of 3%, but a far cry from the G3 average of 31%.
That may be good news for the government since, misrepresentative of the real economy as the market is, any correction will have less of a knock-on effect on economic growth and domestic wealth. And while the domestic share rally has clearly got ahead of itself, by any rational measure the long-term direction of the market should be northwards, but perhaps not much further for now from these levels. Alas, we are no longer in rational territory and the government, the market’s biggest manipulator by far, is likely to act soon.
Politics plays a vitally important role in China’s stock market, from the authorities’ paranoia over possible social unrest that accompanies any major correction to the government’s supposed preoccupation with maintaining the feel-good factor until after the Beijing Olympics. It is ironic that the government’s inability to resist meddling in the market will likely be the source of the correction. According to the head of global capital markets at a leading bank, who is particularly well connected in the mainland China, the government’s latest ruse is to enlist the help of its recently created investment institution, the National Social Security Fund to adjust the market by selling part of its holdings in restricted ‘A’ shares into the market as the trading restrictions are lifted, probably in the autumn.
A correction in China’s domestic share markets is long overdue and certainly on the way, although perhaps not as soon as some might think. Whenever it arrives, watch for government action to start the carnage, not the retail punter.
