Just for a moment, there was a sign of weakness. For three days from August 15, the Shanghai Composite Index (SCI) closed down 6 points, 80 points and then 77 points. Finally, this was China reacting to the credit crunch that had been hurting global markets downwards for the best part of three weeks.
Not that it was much of a reaction. Between the last week of July and mid-August, markets around the world posted double-digit losses in percentage terms. The inward looking China market, meanwhile, sped from around the 4,000-point mark to 4,900-point territory.
At time of writing, the market was standing on the brink of 5,000 points and the newspapers were full of talk about the SCI crossing another “psychologically important” boundary.
Given that it wasn’t 10 months ago that the SCI was reaching 2,000 points for the first time, it could be argued that the market has encountered enough psychological boundaries to warrant an extended session in therapy.
Down at the Red Dragon Fund, we could do with some therapy ourselves, even if this usually means staring at the bottom of a glass. For the past two months, the fund has underperformed the market. The tos and fros that preceded the current charge upwards have not been easy to navigate but it is time to regroup.
We currently have Shanghai Petrochemical 600688 in our portfolio and this stock is showing strength, as investors wait for news from the parent company on impending share structure reforms.
Jinqiao Export 600639, which we bought in anticipation of gains drawn from the interests it has in commercial real estate and domestic brokerages, has yet to deliver on its promise. However, with a number of China’s brokerages reporting strong first half profits, it is worth hanging in there a bit longer.
Harbin Pharmaceutical Group 600664, on the other hand, has yet to resolve its internal disputes and so the stock has been jettisoned.
And what next? Well, for one thing, if global markets continue to struggle and China remains largely insulated from the harm, this means more hot money flowing into the A-share market.
The Qualified Foreign Institutional Investors are also adjusting their strategy. Having warned of asset bubbles when the SCI first topped 4,000, they have since spent May and June adding to their A-share positions. They appear to be becoming more speculative and it will be interesting to see if they continue in this vein.
There are two issues to be wary of. First, the share structure of the A-share market makes it easy to manipulate. For example, the tradable stock of Industrial and Commercial Bank of China 601398 accounts for just 2.7% of its capital stock. For China Life 601628, it is 3.2%. Given that SCI weightings are based on companies’ total capitalization, it isn’t difficult for the institutional investors to manipulate the index by controlling the prices of the index-weighted stocks.
Second, there are still no financial futures. Investors can’t sell short so they can only make money when equity prices go up. This is fundamentally unhealthy.
As a result, China’s stock market is like a game of musical chairs – but the institutional investors are controlling the music and playing it several times. Individual investors are the ones who are left without a place to sit.
In August 2005, CHINA ECONOMIC REVIEW decided to invest RMB10,000 in A-shares. And so the Red Dragon Fund was born…
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