Remember the dot.com era
in the U.S., especially 1999 to March 2000? Technology stocks ruled, valuations
were outrageous, the economy was entering a new paradigm and “this time is
different” justified prices. The Chinese markets have experienced the same
hyperbolic price increases in the last 12 months.
What most U.S. investors
don’t realize is how large the Chinese stock markets have grown in the last
decade in terms of listed companies’ market values. The Shanghai Stock Exchange,
which has more blue-chip companies, is ranked third in the world; the Shenzhen
Stock Exchange, which has more technology and healthcare companies, is ranked
seventh. Chinese A shares are listed on the Shanghai and Shenzhen exchanges. Chinese
companies can also list H shares on the Hong Kong Exchange, which is ranked fifth
in the world. Several hundred Chinese companies have also listed their stock in
the U.S. In total, Chinese stocks had a market value of $10 trillion at the end
of May, second in the world to the U.S. with $27 trillion.
The Chinese exchanges had
a previous stock market bubble that deflated in 2007 with stocks dropping 72
percent and languishing for seven years. Starting in mid-2014, stock prices
started to increase steadily and experienced hyperbolic moves in 2015. The
Shanghai Index was up 60 percent and the Shenzhen Index 122 percent when prices
peaked on June 12, 2015. Since then both exchanges have technically fallen into
bear markets, defined as a market decline of 20 percent or more. The Shanghai
Index has fallen 28.6 percent from its peak and the Shenzhen Index 33.2 percent.
It was a 12-month bull market and a three-week bear market thus far. $3
trillion of market value has been wiped out to date.
Where the market goes from
here is anyone’s guess. Chinese citizens have accumulated $21 trillion of
savings, thus the Chinese markets are retail-driven as opposed to institutional;
individuals account for 90 percent of stock trading. The Chinese government
seems to have encouraged the bull market as they reduced lending rates four
times since November 2014. And Chinese investors have not been shy about using
margin (borrowing money to buy stocks) as it increased from 400 billion yuan to
2.2 trillion yuan ($354 billion) in the last 12 months. China is a big country
of 1.13 billion people, but over 40 million new accounts were opened in 2015.
Although there are now about 250 million brokerage accounts in China, it is
estimated that there are fewer than 100 million investors – less than 10
percent of the population. The typical account trades once a month so the
Chinese are more speculators than long-term investors.
Why would the Chinese
government encourage its citizens to invest in the stock market? Property
prices have started to deflate in most cities so this is an alternative way to
create wealth. Also, Chinese nonfinancial corporations have some of the heaviest
debt balances in the world; higher stock prices would allow them to replace
debt with equity and reduce risk. Higher stock prices would also allow private
or state-owned companies to go public; initial public offerings (IPOs) set new
records in 2015. In fact, many Chinese companies that had listed in the U.S.
and Hong Kong are delisting and listing on the Shanghai and Shenzhen exchanges
because of higher valuations there.
Deflating prices in the
property and stock markets could also deflate domestic confidence and hinder
China’s policy to become more of a domestic consumption-driven economy as opposed
to investment and export-driven. It certainly will not help China sustain its 7
percent economic growth objective. It may also delay China’s stocks being
included in world market indexes such as the MSCI Emerging Market Index, which
was one of the reasons for recent Chinese investor enthusiasm. Beijing has some
policy tools to help stabilize the markets, such as raising margin requirements
and restricting short-selling and new IPOs. Time will tell whether they can
prevent an all-out collapse of the market.
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