Thursday, June 7, 2007

Who Moved The Chinese Market?

Shanghai closed today at 3890.8, up 3.03%. It is also the first time that there are more advances then declines (894 vs. 378) since the announcement of the tripled duty tax on 29 May.

Over the last 7 trading days, Shanghai Composite has corrected by 21% from its peak of 4335 on 29 May to its lowest of 3406 on 5 June, and still by 10% as of today.

This size of correction is totally unexpected by the government, over the last 2 days there were various government officials trying to comfort the over-reacted crowds with bullish comments in different media.

In addition, 4 new equity oriented mutual funds are approved and will be launched next week. Last time when a large number of funds were concurrently approved was on 6 Feb, when the market collapsed by 10% from 30 Jan to 5 Feb.

Obviously the government is trying to fix the aftermath.

So what was the cause for this latest correction? It was not the tripled duty tax, as I mentioned in my last article the practical impact of it is insignificant.

The real cause was the poorly managed and inconsistent message from the government. Just a few days before the 29 May announcement was made by the Ministry of Finance, the media had confirmed with another spokesperson of MoF that there was no such plan.

It is exactly this inconsistency which caused the market panic, as investors have no clue which message could they trust in future.

I think such inconsistency was unintentional, I believe Chinese authorities would learn from this incident and be more careful when government officials talk to media.

Another by-product of this correction is a tightening of the A-share/H-share price gap from the previous 30%+ premium exhibited by A-share. As can be seen from the chart below the Hang Seng China Enterprises Index (which tracks H-share in Hong Kong) has in fact gone up while the A-share index was free falling in the period.

This is the first time inexperienced Chinese investors (17% of the total trading accounts in China were freshly opened in past 4 months) got their fingers burned, at least for a period of time that 17% of the retail investors would remember this incident.

I believe Chinese investors would also start looking at other less risky investment vehicles which they are familiar with, such as QDII (Qualified Domestic Institutional Investor) funds the government recently relaxed. (Up to 50% of a QDII approved fund can be invested in equities from 0% in the past). As Hong Kong is the only authorized market QDII funds can put their money, most of such funds would likely allocate their equity portion to Hong Kong listed H-shares, red chips and Hong Kong blue chips which are all familiar names to Chinese investors, that would be a catalyst to H-share index though the absolute amount is still small comparing to the HK market cap.

Besides, there are more mainland Chinese investors using a grey channel to invest directly in Hong Kong stocks without going through QDII. Though RMB is not a freely traded currency, Chinese citizen is allowed to buy up to US$50K per year for their spending when they travel to Hong Kong. For a family with 3 members it’s already US$150K which is not a small number at all from Chinese standard. Though officially it is not allowed, still some of them would open a HK stock trading account when they travel to HK and place orders over internet or phone. In fact a local Hong Kong broker said today around 50% of its orders are coming from mainland customers. I would not under-estimate this effect which would even be more significant than the QDII channel.

I’ve also adjusted my trading strategy and would allocate part of my portfolio to H-share index ETF (2828.HK) rather than purely on A-share related ETFs (CAF and A-50 Tracker). Now I am equally bullish on both A-share and H-share.

Disclosure: I have LONG positions in H-share index call warrant and A-50 index call warrant


Anonymous said...

This size of correction is totally unexpected by the government??

It may be totally acceptable and expected by the government.

The real cause was the poorly managed and inconsistent message from the government??

It may be perfectly managed to cool down the stock market and educate the inexperienced investors.

Anonymous said...

I'm wondering what gave you such a strong conviction to hold call warrants instead of ETF's, as timing is very important for call warrants.