The unseen

If there is a warm heart beneath the cold, hard cash that dominates the rise of China's stock markets, it is the retail investor. These are the old ladies, young mothers and overworked taxi drivers who felt the squeeze of a four-year bear market but can now smile at the Shanghai Composite Index reaching record highs.

By all accounts, these retail investors are rushing to the market in droves and, during the April-May peak, opening 300,000 or more new stock trading accounts every day. This is the free market as it should be: ordinary Chinese people making money off extraordinary Chinese stocks.

Unfortunately, this everyman quality is also somewhat misrepresented.

Fraser Howie, co-author of the stock market study Privatizing China, offered some sobering analysis at a recent conference. It all pointed to the unproved and likely improvable conclusion that a large chunk of these supposedly retail investments come from the army, police, local governments, state-owned enterprises and private funds.

These government-linked bodies are officially banned from sinking public funds into such risky products.

The total capitalization of the mainland markets is about US$485 billion and US$112.8 billion of it is publicly accounted for – held by funds, Qualified Foreign Institutional Investors (QFII), insurance companies, the National Social Security Fund, brokerages, and so on.

This leaves US$372.2 billion in "unseen" money and, according to Howie's estimates, only US$100 billion of it is held by bona fide retail investors. He believes US$225 billion is controlled by state-owned enterprises, private funds, manipulators and "state organs".

Taking the Shenzhen exchange as an example, Howie said that five million of the 10 million active retail accounts last year traded less than US$13,000 each. Meanwhile, two thirds of the total retail turnover came from one million accounts that traded more than US$130,000 each. It is hard to believe that someone with more than one hundred grand to invest is just your average guy on the street.

So what does all this mean?

First of all, despite its resurgence, the Chinese stock market is still mired in the problems of old, namely poor transparency and shoddy corporate governance.

Perhaps more important, though, is the issue of where government entities are putting their money. If there is a stock crash and local authorities have significant market exposure, then the ripples would be felt much further than originally anticipated.

This episode is eerily similar to the Shanghai pension fund scandal: a government agency has more money than it knows what to do with; legal investment channels offer paltry returns, so the cash finds its way down far riskier paths and officials skim profits off the top or bury losses in the paperwork.

Rather than worry about a deflated stock market bubble, maybe Beijing should tackle the much more daunting task of untangling vested interests and bringing good governance to its financial system.