ASIA FOCUS : CHINA KNOWLEDGE
'Perfect storm' moving in from US will rain on China's stock market no matter what the government does
TIGER TONG
The highly anticipated stamp tax cut has improved sentiment on China's stock market dramatically. However, it might only be a temporary lift because China's stock markets, which were once isolated, are becoming linked more closely to the rest of world.
Today, we can see that the perfect storm that originated from the other side of the Pacific is expected to hit Hong Kong and eventually disperse the optimism felt in Shanghai.
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| The Shanghai Composite Index, a world-beater for two years, has been on a six-month skid, falling below 3,100 points _ nearly 50% off its all-time high of 6,124.04 in October 2007 _ on April 18 before rallying in recent days on optimism about tax cuts. |
The Shanghai Composite Index, which covers both A and B shares listed on the Shanghai Stock Exchange, was one of the world's best performers in the past two years. But in late 2007, the bubble started to burst. As of April 18, the index had fallen below 3,100 points, losing nearly 50% from its all-time high of 6124.04 in mid-October 2007.
On April 20, the Beijing government started to restore market confidence with its "visible hand" by announcing new rules. Pursuant to the new regulation, shareholders are required to sell stocks in a block-trading system if they want to sell a large amount of shares freed up after a lock-up or silent period. The aim is to reduce downward price pressure when such shares are sold directly in the secondary market.
Taking an even more aggressive stand, after the close of market on April 23, the government announced that it would cut the stamp duty on stock trading to 0.1% from 0.3% with effect from April 24. Clearly, Beijing has discerned that 3,000 points is the bottom for the Shanghai bourse.
Spurred by the news, the Index surged by 9.3% on April 24, the biggest gain in seven years. Many stocks reached their 10% daily upward price limit. But the strange debut of Zijin Mining A-shares the following day seemed likely to deter regulators from injecting any more "excitement" into the market in the near future.
A-shares of Zijin Mining, China's biggest gold producer, opened on April 25 at 9.98 renminbi, 40% higher than the IPO price. But in the afternoon trading session, the stock rose by more than 200% to reach RMB 22, which triggered a temporary trading suspension. The shares plunged after trading resumed and closed at RMB 13.92 - nearly 80 times the company's 2007 earnings. Turnover in the single day amounted to 92.5%. The Zijin case reminds investors that the market is still dominated by speculators.
Without continued government intervention, the effect of developments in the US market could take a toll on China's markets. It is a bit counterintuitive since there is a perception that China's stock markets are quite isolated from the rest of world since the country's capital account is still highly regulated, and the currency is not fully convertible. But something has happened in the past few years has caused the once-closed market to be linked to the world more closely.
First of all, China's economy has become tied more closely to the world's. In 2007, China had surpassed the United States as the world's second-largest merchandise exporter, and it is expected to replace Germany in 2009 to become the world's largest exporter. The slowdown in the world economy will certainly generate negative impacts on China's economy, and inevitably filter through to company earnings.
More directly, Shanghai has been linked more closely to New York, through Hong Kong. As of the end of March 2008, among the top 10 Chinese companies measured by market capitalisation in Shanghai, nine were dual-listed in Shanghai and Hong Kong, compared with three at the end of January 2006.
Indeed, as of the end of March 2008, the value of dual-listed companies in the Shanghai top 10 list accounted for 45.3% of Shanghai stock market's total market value, against 17.1% as of the end of January 2006.
This situation has caused a stronger "resonance" effect between Shanghai and Hong Kong. One market in the doldrums will easily affect another even if the latter is showing strong momentum. As an internationalised market, Hong Kong is highly influenced by the US market; a strong correction on Wall Street is likely to bring Hong Kong down. It will at least cap the room for a continued rebound of the Shanghai market.
Wall Street has emerged from the bear market since the Fed bailed out Bear Stearns in mid-March. Compared to its March 10 low, the S&P 500 has surged by more than 10%. But as the Fed is running out of bullets (inflationary pressure will force the Fed to put interest rate cuts on hold from May) and the housing plunge is estimated to be only halfway to the bottom. The new fiscal stimulus package from washington will have a limited impact on easing the pain. The outlook for the US market is certainly not promising. A perfect storm is evolving.
Overall, I am not expecting a continued rally in Shanghai, though I think the downside risk is not big either. Aside from possible government interference, the fact that 3,000 translates into a P/E in the low twenties, suggests that it is a reasonable valuation for cash-rich Chinese investors. Therefore, the doldrums might provide a good opportunity for the government to reinforce its regulations on listed companies and stock markets.
Tiger Tong is an analyst with China Knowledge, a premier provider of trade and investment information on China. Opinions expressed are his own.
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