An avalanche waiting to happen
Stephen Vines says the Chinese authorities can no longer control their stock markets, which are heading for trouble Ivaiting for the bursting of the Chinese share bubble is like waiting for an avalanche. You can hear the rumbling but you have no idea when and where it will strike.
Among the most bemused of those waiting to find out are the Chinese authorities — torn between pride in the prowess of their markets and lack of experience in the way they operate. Last week the government made a tentative attempt to cool the markets by bumping up stamp duty on share deals and there was an immediate tumble in prices, followed by an upward blip and this week a more severe decline. Who knows where the market will be by the time you read this, but all the classic conditions of a stock market bubble are in place: the Shanghai exchange has seen prices rise by 130 per cent last year and another 50 per cent since January. Shares trade at around 50 times earnings (more than double the multiple in most markets) and buying frenzy has resulted in the opening of 100 million share-trading accounts; sometimes more than 300,000 accounts have been opened in a single day.
The authentic voice of the Shanghai bubble is to be found in internet chat-rooms, where the ill-informed avidly exchange information with the downright ignorant, sharing a xenophobic dismissal of foreigners who doubt whether the bubble can be sustained. Meanwhile, people mortgage their homes to buy stocks, and work slows in offices when the exchanges open and punters flick on their computers in search of hot shares.
In most markets the overwhelming bulk of trading is by professionals; in China private investors account for 80 per cent of turnover. Many have never owned a share in their lives until recently and do not even know the names of the companies they're buying; all they know is their stock codes.
China remains a vast, mostly poor and still nominally communist country, in which only about 7 per cent of the population own shares — but they are concentrated in the urban areas where they exert a disproportionate influence on the rest of the nation. The people who run China were happy to see stock markets develop because the essence of the deal between rulers and ruled is that liberty and democracy are bartered for higher living standards. Novice investors marvel at how their holdings have doubled in value and are even more excited by the surefire profits to be had from share offerings by privatised state corporations, deliberately priced to ensure immediate gain. The theory in Zhongnanhai, the Beijing enclave where the leadership resides, is that as long as the urban masses are transfixed by the market, they will not bother about political matters.
If the new investors suddenly discover that markets can plummet, however, politics might rear its head again. Indeed last week in those ubiquitous chat-rooms there was much bitterness directed against the government for its stamp-duty hike. Some people are convinced that the Beijing authorities are so single-mindedly focused on making next year's Olympics a success (as Elliot Wilson described last week) that they will do nothing seriously to upset the public before the Games are safely out of the way.
But this assumes that the fluctuations of the stock market are largely determined by government action — not an unreasonable assumption in a country where the state still controls most of the big listed companies. The last falter in stock prices came on 18 May when the central bank inched up interest rates to encourage investors to switch back into bank deposits and away from speculation. The adjustment was relatively modest, but it sent a message that the government had the power to dampen the enthusiasm for stocks.
Nevertheless, what has really driven Chinese stocks upwards is a vast sea of funds looking for a home. What is not so typical of bubble markets is that there is also some rational basis for the heady share prices. Chinese companies are registering unprecedented rises in profitability. According to Goldman Sachs, the profitability of companies in the A-share market (exclusively reserved for Chinese investors) rose by an average of 82 per cent in the year to March. So there is a basis for expecting higher earnings — but the unrealistic assumptions of Chinese investors are starkly seen in the chasm that has emerged between the prices of companies listed on both the Chinese and Hong Kong exchanges: one share, Lyoyang Glass, was trading in Shanghai at a price 900 per cent higher than in Hong Kong.
As prices surge, China is left without the instruments which can keep markets under control. Notably, there is no derivatives market that would allow investors to gamble on prices falling as well as rising. The authorities appear to have been scared off developing markets of this kind after a disastrous experiment in bond futures trading in 1995, when a major brokerage firm collapsed after trading on false insider information. Moreover, successful derivatives markets require a high degree of corporate transparency, and no one pretends that this is available in China today.
All this begs the question of whether the flood of investment in equities is serving any purpose other than sheer casino-style speculation. In theory, shares are floated on stock markets to provide capital for companies, but in China only 10 per cent of private-sector capital investment in factories and other business ventures comes from the stock market. So what happens to all the money raised by companies rushing on to the Chinese exchanges? A great deal of it goes into buying shares of other companies doing the same thing.
Meanwhile some of the more savvy foreign institutional investors are getting out of this market. Their shares are eagerly snapped up by the 'experts' in the chat-rooms who claim China is different from the rest of the world — where terrible things happen, like stock markets collapsing.
Stephen Vines is the author of Market Panic: Wild Gyrations, Risks and Opportunities in Stock Markets (John Wiley & Sons).
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