It’s a good time to be liquid. The end of the annual session of the National People’s Congress (NPC) on March 18 coincided with the stock market sliding 3.96% to close at 3668.90 points. No prizes for guessing what the investor takeaway was from the NPC: Don’t expect any help from the government; we’re too busy trying to fight inflation.
The Red Dragon Fund sold its holdings in late February while the Shanghai Composite Index (SCI) was still in 4,200-4,300 territory. It was a wise move.
Bank of Communications (601328) was the first to go, fetching RMB11.26 on February 26. As of March 19, it had fallen to RMB10.49. Jiangxi Ganyue Expressway (600269) was sold three days later at RMB17.07. Its price on March 19 was RMB13.54.
The pessimistic mood in the A-share market is driven by a steady stream of unhappy economic data. The consumer price index rose 8.7% year-on-year in February, its sharpest increase in 12 years. Meanwhile, surging commodity prices were largely to blame for the producer price index posting its biggest jump in three years in February, coming in at 6.6%.
But this is only part of the story.
Last month we expressed our concerns about the introduction of a huge tranche of shares to the market as part of the non-tradable share reform program. Based on market prices at the end of 2007, an average US$33.7 billion per month in non-tradable stocks will become fully tradable this year. The impending supply glut has left mutual fund managers in a bind. They are used to being able to dictate prices through their trading strategies but, in this case, the sheer volume of new shares coming online is too great to counter. Prices are falling regardless.
Mutual funds can reduce their blue chip exposure but they must maintain long positions that account for at least 60% of their holdings. Therefore the funds are resigned to losses down the line. Any attempt to boost prices is likely to prompt holders of non-tradable shares to sell up as soon as they get the chance.
“These people are the biggest beneficiaries of the share reform,” one fund manager said. “We’re paying the bill for them.” Nearly all mutual funds are down 20% so far this year.
The investment director at a large fund management company in Shenzhen told reporters in March that his company began selling its holdings at the beginning of the month. He noted that, if the A-share market fell in line with the valuation levels in Hong Kong, then the SCI would be around the 2,000-point mark.
Surprisingly, the securities regulator criticized fund managers for reducing their positions to the minimum 60%. Participating in a conference call on March 11, oficials said that managers should maintain positions of no less than 70%. This is a ridiculous notion. Asking funds to accept such as strategy in a bear market without a hedging mechanism amounts to asking them to cover the cost of the non-tradable share reform program. Investors in the funds will ultimately suffer.
During the conference call, fund managers asked the regulator to introduce rules regarding dividends. This should be a priority for 2008. Last year the central government collected US$29 billion in stamp duty while total dividends paid out by listed firms came to US$25 billion.
The A-share market is bleeding, which points to a bear in the long-term.