A lone console had opened up in the far corner of Shanghai’s Nanjing Securities trading hall, but not for long. Clad in a pea-soup green sweater with hair a short-cut hurricane of maroon, an elderly woman shuffled swiftly over to the console’s number pad and began clacking out commands. After a beat she squinted and adjusted her rose-motif bifocals before throwing her hands up in the air.
“Aiyah!”
She shuffled off dejected, but had soon shaken off the loss like a bad round of mahjong. As with that classic game of quick wit and luck, it is easy to see why she and other individual investors have piled their spare cash and sometimes their savings into mainland China’s so-called A-share market: Profit. Only 14 of the 2,547 firms listed on the Shanghai and Shenzhen stock exchanges saw share prices fall in course of this year’s first four months, according to figures from financial data company Hithink RoyalFlush cited by the newspaper Beijing Youth Daily.
That said company is itself listed in Shenzhen (and that its chairman became a billionaire thanks to the current bull run) detracts none at all from the rally’s reality, even if unease has mounted among international observers, particularly after the Shanghai Composite Index dropped 6.5% on Thursday. It may fall further on Friday. But expectations of a full-on collapse because share prices are totally divorced from financial fundamentals may be misplaced, at least for now.
Indeed, that yawning gap between valuation and actual value is what made the rally possible in the first place. As far as Shanghai and Shenzhen are concerned, market fundamentals couldn’t be less important thanks in large part to the investment approach adopted by the droves of individual investors driving the current rally. These so-called retail traders, often stereotyped as inexperienced gamblers and hailing from every age bracket, aren’t concerned with traditional investment metrics like price-to-earnings ratios.
Instead they’re keeping an eye on policy announcements and banking on further easing measures like bank reserve requirement cuts and stimulus rollouts commonly viewed as good for listed companies, regardless of whether they help China’s flagging economy. In fact, the worse the economy gets, the more government support expands, and China’s individual investors have thus far responded by plowing yet more money into stocks, driving prices even higher.
“The problem at the moment is that it’s very difficult to interpret what’s happening in the markets because they’re being driven not by fundamentals, but by investor sentiment,” said Julian Evans-Pritchard, a China economist at markets research firm Capital Economics. “There’s always some sentiment, but other markets are more grounded, whereas China has become less attached to economic fundamentals—especially in the last six months.”
There may not be an agreed-upon definition for what constitutes an economic bubble, but general consensus has settled on a list of phenomena that any observer of Chinese equities over the past year would find all-too familiar: Large surges in IPOs and newly opened trading accounts; irrational upswings in stock optimism based on only minor growth; speculative stocks greatly outpacing valuation of dividend-paying stocks; and a general drop in financial expertise among those engaging in trading.
But investment in the so-called A-shares traded at the Shanghai and Shenzhen stock exchanges is not directed by the same economic rule book that serves as the basis for other markets’ operations.
“China is more and more driven by views on what policy makers are thinking in terms of supporting the market or not,” Evans-Pritchard said. “You can see this in terms of how often [prices] swing on editorials published in state media, because those editorials often swing [between caution and encouragement] as well, and markets react accordingly.”
One elderly gentleman at the Nanjing Securities trading hall was more critical: “Retail investors will go whichever way the government’s red flag points,” he volunteered, before declining to give even his surname. He added that he sometimes couldn’t figure out why certain stocks had shot up until he’d seen the corresponding policy announcement on TV. The mix of state-owned and commercial newspapers pinned to cork boards on both floors of the hall drove his point home. One headline proclaimed: “Shanghai Composite Index above 4,500 again; ChiNext unceasingly hits new heights”.
These and other features of Chinese securities markets can be traced back to impetus behind the establishment of China’s bourses in the early 90s, when top leaders were looking for a way to turn state-owned firms into economic powerhouses. They first consolidated many smaller companies into a few major ones worthy of listing in Hong Kong and New York, after which these newly minted corporate giants returned home for a victory lap listing on the mainland. However they remained, by requirement, state-owned, with only a portion of shares put up for grabs. In China stocks can freely change hands, but ownership of a listed firm cannot without regulators’ approval.
In lieu of possible ownership rights shareholders would – at least in other markets – still have one reason to keep stocks that aren’t rising: Dividends. These regular payouts skimmed off the top of a company’s profits typically give investors a reason to hold on to stocks through short-term price volatility. But in China cash disbursement is the exception to the rule.
According to a 2013 survey by Palisades Hudson Financial Group, 60% of companies listed in mainland China didn’t pay cash dividends at all. That may be in part because disbursements from Shenzhen and Shanghai-listed stocks are subject to taxes, whereas capital gains made from rising stock prices are not. To combat this obvious crossing of purposes the Shanghai Stock Exchange issued the “Guidelines on Distribution of Cash Dividends” in early 2013 ostensibly mandating all companies to make a 30% payout of profit—but a loophole allowing firms to explain away their failure to do so by giving “alternative uses” of their profits suggests this move was mostly symbolic.
Heng Chen, a professor of economics at Hong Kong University, said they probably wouldn’t help anyways. “Volatility means all the attention is on short-term gains,” Heng said.The current rally is driven by investors seeking ever-escalating share prices that put what pitiable dividends that are offered on the mainland to shame. So long as prices rise at a sufficiently speedy clip within a certain period of time, there will be little incentive for listed firms to start such payouts.
Retail only
The other major difference between mainland markets and the rest of the world is investor makeup: Where giant investment firms dominate the board in London and New York, individual investors make up the majority of traders in Shenzhen and Shanghai and account for far and away more of the daily trading volume than local brokers. Their numbers have only increased since July, when the Shanghai-Hong Kong Stock Connect was first announced.
The speed with which still more retail investors have invested for the first time appeared to take a dramatic leap in late April, when Bloomberg reported that 2.8 million rookie stock pickers had joined the rally in the two weeks ending April 27, five times the average of the past year. The figure was based on the number of new accounts registered, which for the past 17 years had been limited to one per person. But on Monday, April 13 – the start of the two-week period in question – the China Securities Depository and Clearing Corporation lifted the ban on multiple accounts, and that individual investors would be allowed to have as many as 20 open at the same time.
That further muddies the waters for anyone hoping to suss out why certain stocks seem to suddenly do so well, an issue already obscured by investors whose rationale for a given investment can be tenuous at best. A group of middle-aged women clustered in a corner of the Nanjing Securities trading hall said they had no strategy whatsoever—just buying what they heard other people had bought. Asked for his own strategy, one of the men in a cramped alcove of consoles opposite the women snorted, threw back his head and yelled his answer for the benefit of the room: “Strategy? There’s no strategy! We’re all doing this for kicks!”
Whatever the reason, the upswing in investment is undeniable. “Previously people perceived that Chinese households had huge savings for every kind of purpose, but recently research has shown this sort of rebalancing from savings to the stock market,” said Heng, who has done extensive research into Chinese household savings rates. “Some households have even pulled money out of insurance to put into the market.”
That has been compounded by an increase in borrowing money to double-down on investments by individual investors, a practice known as margin lending. Given the potential knock-on effects likely to reverberate throughout the economy should the market tank, regulators have been cracking down on the practice in waves, with a January move to punish overenthusiastic brokers producing the largest valley prior to this week in the Shanghai Composite Index’s mountainous ascent, though that only lasted for about a day.
The effects of the crackdowns have likewise proved fleeting, Pritchard-Evans said, with figures from both mainland bourses showing no significant deleveraging had taken place as of the end of April. That may not spell doom for most individual investors, however, as Heng noted that that regulators in China required traders to have at least a half-million RMB before they could trade on margin. That suggests that while the economic ramifications of a crash would be felt economy-wide, many retail investors would only lose as much as they put in (although there are signs that, too, may be changing).
Yet the age of those trading may be as important as the amount they invest. Older generations in China may have savings to throw around, but if a greater portion of young Chinese have begun trading, any losses could still be felt years down the line. Historically, at least, that has not been the case: China Securities Depository and Clearing has always provided a by-decade annual breakdown in its yearbooks. By the end of 2014, the relative size of each age bracket hadn’t changed too much from 2013 even as the absolute number of accounts increased. Account holders in their 30s and 40s made up over half of the 139.1 million traders as of December 31.
y official statistics released don’t quite match the standard brackets. In late April, China Securities Regulatory Commission spokesperson Deng Ge said that during the first quarter of 2015, 30-40 year-olds accounted for about 32% of nearly 8 million new accounts, while those under 30 accounted for about 36%, and those over 60 made up just 5%, according to a report from the Huaxi Metropolis News.
While it appears that investors under 30 might have been rising as of the end of March, the April lifting of the ban on multiple accounts means new additions no longer represent market demographics one-to-one.
Getting schooled
Recent reports have also noted with alarm a survey showing that two thirds of the new trading accounts opened within the last year—which in total make up more than half of all active A-share accounts on the mainland—had been started by people who had not graduated high school. But Heng said it went beyond that.
“Many retail investors do not even have a middle school education,” he pointed out, shortly before cautioning against the assumption that higher education led to better investment practices. Education, Heng said, “is not a determinant for success, but correlates to things like patience,” which can be useful to traders.
For Johnson Huang, a student at a top university in Shanghai who is known among his peers for an interest in finance, that has proven to be true. Huang entered the market nine months ago to see if he could apply what he’d studied to investing in Chinese stocks, only to learn there was so much hidden information that making sound financial decisions was all but impossible.
“I discovered the stock market in China has nothing to do with finance. Many of the %K line charts are faked, and the values of different stocks are evaluated based on nothing,” Huang said. “It’s all about government policies and inside information.”
Retiree Xu Chungen could’ve told him that. Sporting a faded blue Nike cap and matching trousers, Xu said he’d caught the investing bug working at one of the first mainland companies to list back in the early 90s. Smiling at the thought of his earnings, he claimed he’d made hundreds of thousands of yuan during his trading career, and noted he still bought a copy of the newspaper Sichuan Fianance every day.
Having survived the last bubble’s popping in 2007, Xu said he had confidence that government would handle this latest rally better than it had those prior. As he spoke on the steps outside of the trading hall, investment consoles behind the hall’s glass façade sounded just-finished trades with a ceaseless staccato of scattershot pings, like sonar machines gone haywire. “There are too many individual investors in the Chinese stock market, especially those without experience who have been flooding in after they sensed an opportunity to make money,” Xu said.
The upshot is that a deteriorating economy is actually of great benefit to mainland stocks, since government support — particularly cuts to banks’ reserve requirement ratio — has thus far proven a sure-fire ticket to boosting the investor sentiment driving prices upward. This seems to have produced a vicious, virtuous cycle in which the worse the real economy becomes the better Chinese stocks perform, flying ever-higher beyond the levels at which a traditional market would price them. So far that has been a boon for Beijing.
“The government actually desperately needs a boom in the stock market,” Heng said. Indeed, on Thursday the National Bureau of statistics said in a statement on its website that equity earnings were responsible for April’s rebound in industrial profits. The ongoing rally has been incredibly profitable for the Chinese government, the ultimate owner of many listed state-owned companies; this has provided a boost for China’s leaders as they attempt to deal with serious shifts in the composition of the country’s economic drivers and shortfalls in growth expected to see further exacerbation through the year’s end.
Even should economic realities begin to worry retail investors rather than egg them on, Capital Economics’ Evans-Pritchard said that if a selloff began it might not escalate to a crash, since policymakers could still step in to prevent a sharper downturn. For now, at least, they don’t seem willing to let the market stop growing. “It’s a question of when, and we don’t think it will happen soon given the current conditions,” he said, “but it has to happen at some point.”
Until then the investors at the Nanjing Securities trading hall most likely to take a real haircut may be those who want one. By half-past ten an enterprising young man was offering day traders a trim at the top of the staircase on the second floor. One middle-aged woman clutching a dark leather purse had taken him up on it, and as the morning wore on little tufts of black began to pile at her feet. ♦
Author & photographer: Hudson Lockett (@KangHexin)
Research: Nancy Gong, Andrew Ross