Investing in local Chinese Equities; akin to riding a moped in China

Investing in local Chinese equities is a bit like riding a moped in China, crowded and very dangerous! Last week, the Shanghai Composite Index of mainland Chinese equities fell 13.3%, the worst weekly decline since 2008. This is the second time this year we’ve seen a correction of more than 10%; it fell 10% in two days at the end of May. The index then rose sharply to a new high on Friday June 12^th, before the decline last week. While the index is still up almost 40% YTD and more than double the level a year ago, new investors lured by the near parabolic move in stocks will certainly be hurting.

Ironically, this surge in the local Chinese equity market has occurred at a time when concern over the slowdown in the Chinese economy has been at its highest in years. This is a reminder that the economy and the stock market don’t always move in tandem in the short term, while also giving the talking heads an excuse to bestow upon us sage wisdom like  ‘the stock market is a discounting mechanism on the future’. The reality is that the Chinese people have embraced rampant stock speculation with a fervour that would make the tulip traders of the 17^th century proud!

The A-Shares of mainland Chinese companies, quoted in Renminbi currency and traded on the Shanghai and Shenzhen stock exchanges, have been bid recklessly higher, trading at a significant premium to their Hong Kong listed counterparts. Fickle foreign capital cannot be blamed. A-shares are available only to mainland citizens, with some foreign ownership permitted subject to quotas under the Qualified Foreign Investor system. This issue of foreign accessibility was a factor in in the recent decision by Index provider MSCI not to include mainland Chinese shares in the MSCI Emerging markets index.

The government is taking steps toward liberalising their capital markets, part of a wider effort to ensure that Chinese interests are more fairly reflected in a world still seen to be shaped by the Western powers. The Shanghai-Hong Kong Stock Connect link has helped, while the looser monetary policy stance of the People’s Bank of China and the surge in margin lending have been key ingredients for fostering the demand from new investors to join the equity party. The numbers are staggering, In March, 4.8 million new stock-trading accounts were opened, with reports of over a million stock-trading accounts being opened every week in China.

It is difficult to see this as the end of the run in Chinese equities, since the People’s Bank of China and the government will continue to provide fuel for this domestic stock mania – in the form of looser monetary policy and fiscal stimulus if needed – in their efforts to prevent a sharp slowdown in the economy.  Still, like riding a moped in China, investors in Chinese equities should be prepared for a memorable and heart stopping journey!