Beijing was careful not to surrender control over the companies it had just sold by designating a large class of shares – around 70% of the total, in fact – as non-tradable shares held by the government or by government subsidiaries. These shares were called government shares or legal person shares, but the beneficial owner remained the people's government.
If the notion of buying something you can't own sounds strange to you, consider that many residents of New York City have done just that. Throughout the 1970s and 1980s, condominiums and coops were bought by just about everyone, even though it was a fairly transparent scheme by which your landlord could sell you the apartment you lived in and then make you continue to pay rent through high management fees. As long as real estate prices rose it was a great deal, but during soft patches – the most recent one lasted from 1987 to 1994 – a lot of residents felt the pain.
China's financial regulators have been busy reforming the share structure of listed companies, trying to eliminate the threat posed by having around 70% of all listed firms' shares in the hands of one beneficial shareholder – the central government. Previous efforts to drive away this cloud hanging over the indices only provoked runs on the markets as investors tripped over themselves in their rush to get out before their shareholdings were diluted and their share prices fell.
Money for nothing
In 2005, the government tried compensating existing shareholders with additional shares and even with cash. Not surprisingly, the prospect of something for nothing worked. Speculators – sorry, investors – actually rushed into shares which were about to announce reforms in hopes of receiving compensation. After the reform packages were announced, these same long-term investors sold the shares, dropping the share prices of the newly-reformed companies by double-digit percentages.
The funny thing is, these share reform plans are just that: plans. In most cases, they are merely outlines of what the companies plan to do but they specify that any conversion of non-tradable government shares into tradable A-shares is at least one year away and will be phased in over periods of up to four years. The current G-share reforms therefore appear to be causing speculative activity which will be repeated as shares actually become tradable in the future.
In order to keep a handle on things, the exchanges even created a G-share index, which starts off at the round level of 1,000 points. Having its own index will be a very useful means of gauging the longer-term success of this project, so stay tuned.
As we head into the New Year – Chinese New Year, that is – it's time to take stock of where we are. In spite of share reforms and other changes, A shares are on a roll, having started a rapid ascent in December. At the time, it was attributed to year-end window dressing by local fund managers anxious to augment their bonuses. It now seems that all investors are discounting what many observers believe will be a sweet spot in China's economic growth, with low inflation and relatively high GSP growth accompanied by a structural shift away from high fixed asset investment.
Now for our stocks:
Baosteel is moving off its lows but we believe this reflects rises in the A-shares and no specific news about the company. Although steel is still looking to suffer from excess production capacity, Baosteel will clearly be among the winners and may even hoover up a few competitors into the bargain. We'll stick with what we've got here.
China Unicom's share price has gone into breakout mode, passing its 200-day moving average on significantly higher value traded. Drive through the countryside and you'll see a lot of Unicom base stations; growth in rural incomes and rural business activity will benefit Unicom at the expense of arch-rival China Mobile.
Oriental Pearl Tower and XJ Electric have generally underperformed although both are above our purchase prices. With the holidays coming up, it's best to consolidate holdings into a liquid stock, so I'm selling both Oriental Pearl and XJ and putting the money into China Unicom. These transactions may be reversed later but there's no point holding illiquid stocks going into a market holiday.