The approval of five new mutual funds, reported in early February, was a sign that China’s securities regulator had accepted that the downward correction in the country’s stock markets was complete.
New funds were suspended in December amid government fears that large inflows of cash from retail investors were creating a stock market bubble. Mutual funds raised more than US$50 billion in 2006, around US$20 billion of that coming in November and December.
But a mixture of real and expected market cooling measures from Beijing had their intended effect as the Shanghai Composite Index (SCI) fell as much as 15% from its January 22 peak of over 2,933.
In addition to stopping inflows through the mutual funds embargo, the China Banking Regulatory Commission ordered banks to take care they weren’t making loans that were promptly sunk into the stock market.
The real estate market, also the subject of bubble fears in Beijing, was hit by a new tax, which sent developers’ stock prices sliding and had a knock-on effect on the whole market.
Cheng Siwei, a vice-chairman of the National People’s Congress, also contributed to the decline. Speaking to the Financial Times on January 30, he expressed concerns about a stock market bubble and warned that many investors would end up losing out.
This was enough to fuel fears of further government tightening measures and the SCI fell a massive 5% the following day.
Having settled at around 2,780, a smaller drop came on February 5 as investors ditched financial and other large cap stocks due to overvaluation fears. Industrial Bank, making its trading debut following a heavily oversubscribed US$2 billion initial public offering, was affected by the general market malaise and underperformed.
From an intra-day low of 2,541 on February 6, the SCI returned to the 2,700 region by the end of the week and analysts said they expected it to stay there in the "policy vacuum period" ahead of the National People’s Congress in March.
Having traded at as much as 40 times 2005 earnings in January, the average price-to-earnings ratio in the market has fallen to about 35. This may still be high compared to other markets, but the resumption of mutual fund approvals suggests it’s a ratio Beijing can live with, at least for now.