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China - Main index touching 8 year lows, is this the moment to enter?
- Thread starter CN2000
- Start date
Hi,
I am a US citizen living in China, so here's my 2 cents.
The economy is good and solid. Real estate is hot but everything else is just fine. I lived in the US during the dotcom bubble and could clearly tell that it had got out of hand. No such signs in China. People work very hard and are frugal.
Stock markets have been declining for a while. I went to one of the local brokerage houses and one can clearly tell its now a ghost of what it was about 5 years ago. The brokerage had about 100 computers that clients could use to trade. Now they have maybe 10. The whole place is depressed. If this is not a classic sign of a bottom, I dont know what is.
Foreigners cannot own most of the Chinese shares. I very much want to play the Shanghai composite index but have found no way of doing so. Stocks trading on Hongkong are way too expensive and follow a different rhythm. Xinhua index is not at all similar to Shanghai. IB keeps pushing it because they are a market maker in its options - but bottom line Xinhua not equal to Shanghai. ADR's in the US also follow a different rhythm. I have owned ADRs for about 10 years but would now like exposure to the Shanghai index.
I think this IS the time to play the Chinese market. When everyone knows about it and it is easy to trade, most of the gains will be far gone. Now is the time - but how?
As for comments about communist etc. dont believe the media. I have learnt this first hand. Take everything the media tells you and what you think you know and throw it in the trash can - that would be a good beginning to start understanding China.
Adios.
I am a US citizen living in China, so here's my 2 cents.
The economy is good and solid. Real estate is hot but everything else is just fine. I lived in the US during the dotcom bubble and could clearly tell that it had got out of hand. No such signs in China. People work very hard and are frugal.
Stock markets have been declining for a while. I went to one of the local brokerage houses and one can clearly tell its now a ghost of what it was about 5 years ago. The brokerage had about 100 computers that clients could use to trade. Now they have maybe 10. The whole place is depressed. If this is not a classic sign of a bottom, I dont know what is.
Foreigners cannot own most of the Chinese shares. I very much want to play the Shanghai composite index but have found no way of doing so. Stocks trading on Hongkong are way too expensive and follow a different rhythm. Xinhua index is not at all similar to Shanghai. IB keeps pushing it because they are a market maker in its options - but bottom line Xinhua not equal to Shanghai. ADR's in the US also follow a different rhythm. I have owned ADRs for about 10 years but would now like exposure to the Shanghai index.
I think this IS the time to play the Chinese market. When everyone knows about it and it is easy to trade, most of the gains will be far gone. Now is the time - but how?
As for comments about communist etc. dont believe the media. I have learnt this first hand. Take everything the media tells you and what you think you know and throw it in the trash can - that would be a good beginning to start understanding China.
Adios.
Quote from svrart:
Hi,
I am a US citizen living in China, so here's my 2 cents.
The economy is good and solid. Real estate is hot but everything else is just fine. I lived in the US during the dotcom bubble and could clearly tell that it had got out of hand. No such signs in China. People work very hard and are frugal.
Stock markets have been declining for a while. I went to one of the local brokerage houses and one can clearly tell its now a ghost of what it was about 5 years ago. The brokerage had about 100 computers that clients could use to trade. Now they have maybe 10. The whole place is depressed. If this is not a classic sign of a bottom, I dont know what is.
Foreigners cannot own most of the Chinese shares. I very much want to play the Shanghai composite index but have found no way of doing so. Stocks trading on Hongkong are way too expensive and follow a different rhythm. Xinhua index is not at all similar to Shanghai. IB keeps pushing it because they are a market maker in its options - but bottom line Xinhua not equal to Shanghai. ADR's in the US also follow a different rhythm. I have owned ADRs for about 10 years but would now like exposure to the Shanghai index.
I think this IS the time to play the Chinese market. When everyone knows about it and it is easy to trade, most of the gains will be far gone. Now is the time - but how?
As for comments about communist etc. dont believe the media. I have learnt this first hand. Take everything the media tells you and what you think you know and throw it in the trash can - that would be a good beginning to start understanding China.
Adios.
Disclosure, I am Chinese, and have somewhat of a passing interest in
China.
The China securities regulation is problematic, securities fraud is
rampant. As someone pointed out, most of the well run firms would go
public in Hang Seng anyways, where the financial disclosure rules are better,
but still by no means foolproof, see the China Aviation Oil (CAO) blow up in
Singapore.
As a whole, I have little short term confidence in chinese listed firms.
Besides, shorting is prohibited, the only way that I know of to short chinese
equities is through OTC contracts like a CFD. In a depressed stock market,
lack of liquidity may also poses a significant problem.
Long term is a different story, the domestic capital market will recover,
given the long-term need for capital. But I am not an economist, and don't
have the confidence of a long-term macro hedge fund.
The Economist this week has some very good opinions on China, which I will
pilfer here. China in a lot of way is like Japan in the late 80s, remember Sony
buying Paramount, and the outcry of Protectionism? Remember Yen hiting
new highs against USD? Remember all the hoopla about Tokyo real estate?
But now, almost 15-17 years on, it is Japan's economy that has yet to
recover. I am not guessing that China will go through 10 years of deflation ala
Japan (not an economist), but the potential is there.
As a Chinese, I want to see China succeed, but I am seeing warning
signs in a public market lacking good transparency with inadequate
regulatory oversight.
Just my $0.02
Quote from svrart:
Hi,
I am a US citizen living in China, so here's my 2 cents.
The economy is good and solid. Real estate is hot but everything else is just fine. I lived in the US during the dotcom bubble and could clearly tell that it had got out of hand. No such signs in China. People work very hard and are frugal.
Stock markets have been declining for a while. I went to one of the local brokerage houses and one can clearly tell its now a ghost of what it was about 5 years ago. The brokerage had about 100 computers that clients could use to trade. Now they have maybe 10. The whole place is depressed. If this is not a classic sign of a bottom, I dont know what is.
Foreigners cannot own most of the Chinese shares. I very much want to play the Shanghai composite index but have found no way of doing so. Stocks trading on Hongkong are way too expensive and follow a different rhythm. Xinhua index is not at all similar to Shanghai. IB keeps pushing it because they are a market maker in its options - but bottom line Xinhua not equal to Shanghai. ADR's in the US also follow a different rhythm. I have owned ADRs for about 10 years but would now like exposure to the Shanghai index.
I think this IS the time to play the Chinese market. When everyone knows about it and it is easy to trade, most of the gains will be far gone. Now is the time - but how?
As for comments about communist etc. dont believe the media. I have learnt this first hand. Take everything the media tells you and what you think you know and throw it in the trash can - that would be a good beginning to start understanding China.
Adios.
I agree with what you say about the economy and about the media trash can. I'd also say there are some good opportunities in the Shanghai market, however the thread was about picking-up China shares while they are at a bottom. I was pointing out that the Shanghai Index does not tell the whole story (most people on Elitetrader cannot trade the H-share futures anyway as they are not available to US residents). Generally, the better run companies do have a listing overseas.
HK is certainly not more expensive than Shangai. The H-share index, which I posted a chart of, is trading at around 10x earnings compared to the Shanghai composite which is at around 17x earnings. There are approximately 30 stocks listed in Shanghai which are also listed in Hong Kong, all but 3 trade at a big discount in Hong Kong compared to their China counterpart. For example, Luoyang Glass trades at 0.80 in HK but in Shanghai it trades around $2.30. The shares are exactly the same, nice arb if you could do it!
There are also ADRs on around 15 chinese companies, most of which have listings in HK. Naturally these trade at the same prices. Liquidity is not great, but if there is enough liquidity then commissions would be alot lower than buying either HK listed or Shanghai listed equities.
As a foreigner you are also able to buy the China B shares listed in Shanghai, most of these also trade at a substantial discount to their A shares.
China - with the main index touching 8 year lows, is this the moment to enter the market?
Part II
First, thank you all for the comments posted and the opinions expressed.
After we have seen an historical summary, let us have a look on the companies listed and stockmarket regulations.
The Chinese stockmarket as been mainly used to support the loss-making SOE sector and to raise fiscal revenue. This contrasts with other capitalist states that use the markets to improve the efficiency of capital allocation and to provide investment resources for enterprises as well an opportunity of varying the costs and risks of their financing.
Developed countries stockmarket rely on an array of institutions to realize its benefits. These institutions, like free press, independent legal system, professional underwriters, unrestricted international investment and a group of mature institutional investors are not (yet) present in China. Young stockmarkets are often poorly regulated because of official's lack of expertise in regulation and the limited resources available. However, and important additional factor in the Chinese context is the conflict between the CSRC's two mandates.
Since 1998 the CSRC has been the national regulator, charged with enforcing rules, maintaining order and generally protecting investors, especially small ones. Yet the regulator is also a government agency, operating under party direction, and such is has also been mandated to support the government's industrial policy. This has primarily involved supporting former SOEs.
At present there are more than 1300 companies listed in Shanghai and Shenzhen. Whenever companies were listed the state retained large controlling stakes. The poor quality of listed companies is the cause of the market's most serious problems, and until corporate performance and governance standards improve, there will be no significant improvement in the market as a whole. The vast majority of listed companies are restructured SOEs that remain owned and controlled by state entities (despite the fact that after having been converted into "shareholding" enterprises they lost their official classification as state-owned companies).
By year end 2000, in 42% of listed companies in China the largest shareholders were state organs, and in most of the others it was SOEs who enjoyed control. Tradable individual shares, the private part of the market, account for only 25-35% of a typical listed firm's equity capital. But many of these shares are held by other state-owned industrial enterprises, securities companies and investment funds. Although state shareholder may appear to have significant control, in practice their influence is limited. MOF (Ministry of Finance) bureau officials have neither the time nor the financial incentives to get involved much in the management of the firms in which they hold equity on behalf of the state. Rather, in practice, it is usually the LP shareholder who controls these companies, even in which the state shareholder has a larger stake.
The LP shareholders do have the financial incentives and usually the political backing to take an active role. As a result, listed companies suffer from what is sometimes referred to as "one-shareholder dictatorship" and the corporate governance problems that inevitably result. The cards are stacked in favour if the LP shareholder, which, if it is state-owned, often has the backing of local government; is often intimately knowledgeable about the listed company (having been involved in its administration pre-restructuring); and has unmatched power on the board. Given an inefficient regulator, deficient minority shareholder rights and the wider problems associated with a weak rule of law, it has been easy for LP shareholders to abuse their power and exploit their listed companies without regard for the interests of other shareholders. LP shareholders generally have not been interested in their listed firm doing well over the long term since with weak regulation by the CSRC and help from local officials they can easily steal funds and assets from the company in the short run.
There is frequent political interference in the operation of listed companies, often more so than before listing because of the additional funds available. Major business and investment decisions will often require the authorization of the firm's party committee. Firms can be leaned on to buy and absorb other state-owned firms, which are experiencing difficulties, or they can be persuaded to invest in projects that have political significance but little economic logic. Downsizing - sacking staff - is difficult when they party committee has a mandate to preserve jobs. It is useful to think of the typical listed company as a machine - a capital-destroying machine. Bountiful capital, garnered from initial and rights issues, is funneled into the company. And like a very efficient machine, all the capital disappears somewhere, either destroyed by inefficient operations or leaving by the back door. Local government keeps it going by providing preferential tax policies and bank loans.
One of the most obvious indications of the poor quality of listed companies is their small dividend payments. Why low dividend distribution in China? One reason is that small shareholders, the principal beneficiaries of dividends, have little power. They are easily outvoted at shareholders' meetings by the dominant shareholders and have little legal protection. Large shareholders do not usually worry about dividends since they benefit in more underhand ways. Another reason is that there is little motive for companies to worry about losing investors. Given the limited supply of equities, the lack of alternative investment options and the amount of misinformation in the market, there are few incentives to attract long-term shareholders by paying dividends. In the west, small shareholders also wield little power. But they benefit from greater legal protection and the fact that institutional investors enjoy significant clout and will sell shares in a company if it does not maintain a healthy dividend policy.
The only way a value-destroying company can survive is if its managers, accountants and auditors fake its numbers. It is difficult ¨C some would say impossible ¨C to assess the real financial health of most listed companies in China since their accounts are so unreliable. Accountancy firms remain state-owned, and although they have been separated from day-to-day administrative control of the government (at least in theory), this status creates numerous conflicts of interest. Listed companies, their accountants and auditors are often owned by the same local government. One rule of thumb has long been to ignore their accounts completely.
On the positive side we can say that 20 years ago China did not have an accounting industry. Much of the legal infrastructure now in place, especially the rules governing listed-company disclosure, is comprehensive, detailed and of high quality.
To be continued...
Note: these are excerpts of the book "China's stockmarket, by Stephen Green" and several articles from the Wall Street Journal Asia Edition. And yes, I live in China.
Part II
First, thank you all for the comments posted and the opinions expressed.
After we have seen an historical summary, let us have a look on the companies listed and stockmarket regulations.
The Chinese stockmarket as been mainly used to support the loss-making SOE sector and to raise fiscal revenue. This contrasts with other capitalist states that use the markets to improve the efficiency of capital allocation and to provide investment resources for enterprises as well an opportunity of varying the costs and risks of their financing.
Developed countries stockmarket rely on an array of institutions to realize its benefits. These institutions, like free press, independent legal system, professional underwriters, unrestricted international investment and a group of mature institutional investors are not (yet) present in China. Young stockmarkets are often poorly regulated because of official's lack of expertise in regulation and the limited resources available. However, and important additional factor in the Chinese context is the conflict between the CSRC's two mandates.
Since 1998 the CSRC has been the national regulator, charged with enforcing rules, maintaining order and generally protecting investors, especially small ones. Yet the regulator is also a government agency, operating under party direction, and such is has also been mandated to support the government's industrial policy. This has primarily involved supporting former SOEs.
At present there are more than 1300 companies listed in Shanghai and Shenzhen. Whenever companies were listed the state retained large controlling stakes. The poor quality of listed companies is the cause of the market's most serious problems, and until corporate performance and governance standards improve, there will be no significant improvement in the market as a whole. The vast majority of listed companies are restructured SOEs that remain owned and controlled by state entities (despite the fact that after having been converted into "shareholding" enterprises they lost their official classification as state-owned companies).
By year end 2000, in 42% of listed companies in China the largest shareholders were state organs, and in most of the others it was SOEs who enjoyed control. Tradable individual shares, the private part of the market, account for only 25-35% of a typical listed firm's equity capital. But many of these shares are held by other state-owned industrial enterprises, securities companies and investment funds. Although state shareholder may appear to have significant control, in practice their influence is limited. MOF (Ministry of Finance) bureau officials have neither the time nor the financial incentives to get involved much in the management of the firms in which they hold equity on behalf of the state. Rather, in practice, it is usually the LP shareholder who controls these companies, even in which the state shareholder has a larger stake.
The LP shareholders do have the financial incentives and usually the political backing to take an active role. As a result, listed companies suffer from what is sometimes referred to as "one-shareholder dictatorship" and the corporate governance problems that inevitably result. The cards are stacked in favour if the LP shareholder, which, if it is state-owned, often has the backing of local government; is often intimately knowledgeable about the listed company (having been involved in its administration pre-restructuring); and has unmatched power on the board. Given an inefficient regulator, deficient minority shareholder rights and the wider problems associated with a weak rule of law, it has been easy for LP shareholders to abuse their power and exploit their listed companies without regard for the interests of other shareholders. LP shareholders generally have not been interested in their listed firm doing well over the long term since with weak regulation by the CSRC and help from local officials they can easily steal funds and assets from the company in the short run.
There is frequent political interference in the operation of listed companies, often more so than before listing because of the additional funds available. Major business and investment decisions will often require the authorization of the firm's party committee. Firms can be leaned on to buy and absorb other state-owned firms, which are experiencing difficulties, or they can be persuaded to invest in projects that have political significance but little economic logic. Downsizing - sacking staff - is difficult when they party committee has a mandate to preserve jobs. It is useful to think of the typical listed company as a machine - a capital-destroying machine. Bountiful capital, garnered from initial and rights issues, is funneled into the company. And like a very efficient machine, all the capital disappears somewhere, either destroyed by inefficient operations or leaving by the back door. Local government keeps it going by providing preferential tax policies and bank loans.
One of the most obvious indications of the poor quality of listed companies is their small dividend payments. Why low dividend distribution in China? One reason is that small shareholders, the principal beneficiaries of dividends, have little power. They are easily outvoted at shareholders' meetings by the dominant shareholders and have little legal protection. Large shareholders do not usually worry about dividends since they benefit in more underhand ways. Another reason is that there is little motive for companies to worry about losing investors. Given the limited supply of equities, the lack of alternative investment options and the amount of misinformation in the market, there are few incentives to attract long-term shareholders by paying dividends. In the west, small shareholders also wield little power. But they benefit from greater legal protection and the fact that institutional investors enjoy significant clout and will sell shares in a company if it does not maintain a healthy dividend policy.
The only way a value-destroying company can survive is if its managers, accountants and auditors fake its numbers. It is difficult ¨C some would say impossible ¨C to assess the real financial health of most listed companies in China since their accounts are so unreliable. Accountancy firms remain state-owned, and although they have been separated from day-to-day administrative control of the government (at least in theory), this status creates numerous conflicts of interest. Listed companies, their accountants and auditors are often owned by the same local government. One rule of thumb has long been to ignore their accounts completely.
On the positive side we can say that 20 years ago China did not have an accounting industry. Much of the legal infrastructure now in place, especially the rules governing listed-company disclosure, is comprehensive, detailed and of high quality.
To be continued...
Note: these are excerpts of the book "China's stockmarket, by Stephen Green" and several articles from the Wall Street Journal Asia Edition. And yes, I live in China.
Quote from svrart:
As for comments about communist etc. dont believe the media. I have learnt this first hand. Take everything the media tells you and what you think you know and throw it in the trash can - that would be a good beginning to start understanding China.
Adios.
yeah, true. how about that whole Yukos story? Totally blown out of proportion.
communist governments do not steal private property, once it's had value added to it.
If China softens, short crude....
China Oil
July 14, 2005
From China, Some Relief on Oil Demand
By KEITH BRADSHER
PARIS, July 13 - A sudden and mysterious drop in China's oil consumption helped to push down the International Energy Agency's estimate on Wednesday of global demand for this year.
After growing 11 percent in 2003 and 15.4 percent last year, China's overall oil use declined 1 percent in the second quarter from the comparable quarter a year earlier, the agency said.
The drop is the latest in a series of unclear and often conflicting indications about whether the Chinese economy is still growing strongly. Top officials of the agency said in interviews they believed that the decline was temporary and that they expected Chinese demand to rebound in the second half of the year, but added that world oil prices could take a heavy blow if Chinese use did not increase.
The International Energy Agency, supported by the governments of the world's leading consuming nations, has recently become known for warning that the world does not have enough oil and calling for the Organization of the Petroleum Exporting Countries to push its member countries to increase their output. But William C. Ramsay, the agency's deputy executive director, said Wednesday that there were signs that worldwide production capacity was starting to move ahead of demand for the year, and he expressed surprise that oil prices had nonetheless stayed high.
"There are not the conditions out there right now that should lead to these kinds of prices," he said in an interview in his office here.
The international oil market has gotten out of line with the availability of oil, he said, adding: "It gets in one of these bullish moods and it has to be dynamited out of it. The fundamentals are not disquieting."
While many traders have expressed concern about China's announcement a week ago that it was close to completing the first of three oil tank farms for a strategic reserve, Mr. Ramsay said he doubted that Chinese officials would opt to fill the reserve quickly as long as oil remained around $60 a barrel. [In New York on Wednesday, oil for August delivery declined 61 cents, settling at $60.01 a barrel.]
China's strong demand for energy has helped push Cnooc, one of its leading oil companies, to make an $18.5 billion proposal to acquire Unocal of California.
Officials of the International Energy Agency said there were four possible explanations for China's drop in oil demand in the second quarter, the most probable being that this was a temporary decrease. The most likely cause, said Fatih Birol, the agency's chief economist and head of economic analysis, was that China had not been allowing the domestic price of electricity and many refined products, like gasoline and diesel fuel, to rise nearly as quickly as world prices. This has caused power-generating concerns and service stations to sell less electricity, and less gasoline and diesel fuel, so as to limit their losses.
Many Chinese power stations have stopped burning fuel oil to produce electricity because the prices they are allowed to charge per kilowatt are not high enough to cover the cost of importing fuel. Chinese refiners have been selling part of their output overseas at higher prices than they can get in the highly regulated domestic market - where gasoline, for example, now sells for $1.63 a gallon.
China's consumption of fuel, a portion of overall oil consumption, plunged 19 percent in the second quarter from a year earlier, said Jeff Brown, an oil-demand analyst here, while growth in refined fuel consumption slowed to a crawl.
Mr. Birol said that artificial energy shortages caused by distorted prices were the most likely basis for the curtailed availability of fuel, especially diesel.
But while diesel-fuel shortages and lines of trucks at empty service stations were a visible problem in China in April, they were not evident during trips over the last three weeks through southern China and to Beijing, and there has been little talk of continuing shortages in news media on the mainland or in Hong Kong.
When told this, Mr. Birol said there had been a vigorous debate in the last two days within the International Energy Agency over how to explain the decline in Chinese consumption, and he acknowledged that other, longer-term explanations were possible.
These include the possibility that the overall Chinese economy is starting to slow, that China is generating more of its electricity from coal instead of oil, and that China is improving energy conservation in response to high prices.
Economic statistics have been contradictory. Exports are still growing rapidly. But energy-intensive production of steel, cement and other construction material has started to slow as the government cracked down on real estate speculation.
In the last year, China has considerably expanded the production capacity of its coal mines and, just as important, the capacity of its railroad system to haul coal to markets. It has also exhorted businesses and households to use less energy, through steps like setting thermostats higher so air-conditioning systems do not have to work as hard.
China Oil
July 14, 2005
From China, Some Relief on Oil Demand
By KEITH BRADSHER
PARIS, July 13 - A sudden and mysterious drop in China's oil consumption helped to push down the International Energy Agency's estimate on Wednesday of global demand for this year.
After growing 11 percent in 2003 and 15.4 percent last year, China's overall oil use declined 1 percent in the second quarter from the comparable quarter a year earlier, the agency said.
The drop is the latest in a series of unclear and often conflicting indications about whether the Chinese economy is still growing strongly. Top officials of the agency said in interviews they believed that the decline was temporary and that they expected Chinese demand to rebound in the second half of the year, but added that world oil prices could take a heavy blow if Chinese use did not increase.
The International Energy Agency, supported by the governments of the world's leading consuming nations, has recently become known for warning that the world does not have enough oil and calling for the Organization of the Petroleum Exporting Countries to push its member countries to increase their output. But William C. Ramsay, the agency's deputy executive director, said Wednesday that there were signs that worldwide production capacity was starting to move ahead of demand for the year, and he expressed surprise that oil prices had nonetheless stayed high.
"There are not the conditions out there right now that should lead to these kinds of prices," he said in an interview in his office here.
The international oil market has gotten out of line with the availability of oil, he said, adding: "It gets in one of these bullish moods and it has to be dynamited out of it. The fundamentals are not disquieting."
While many traders have expressed concern about China's announcement a week ago that it was close to completing the first of three oil tank farms for a strategic reserve, Mr. Ramsay said he doubted that Chinese officials would opt to fill the reserve quickly as long as oil remained around $60 a barrel. [In New York on Wednesday, oil for August delivery declined 61 cents, settling at $60.01 a barrel.]
China's strong demand for energy has helped push Cnooc, one of its leading oil companies, to make an $18.5 billion proposal to acquire Unocal of California.
Officials of the International Energy Agency said there were four possible explanations for China's drop in oil demand in the second quarter, the most probable being that this was a temporary decrease. The most likely cause, said Fatih Birol, the agency's chief economist and head of economic analysis, was that China had not been allowing the domestic price of electricity and many refined products, like gasoline and diesel fuel, to rise nearly as quickly as world prices. This has caused power-generating concerns and service stations to sell less electricity, and less gasoline and diesel fuel, so as to limit their losses.
Many Chinese power stations have stopped burning fuel oil to produce electricity because the prices they are allowed to charge per kilowatt are not high enough to cover the cost of importing fuel. Chinese refiners have been selling part of their output overseas at higher prices than they can get in the highly regulated domestic market - where gasoline, for example, now sells for $1.63 a gallon.
China's consumption of fuel, a portion of overall oil consumption, plunged 19 percent in the second quarter from a year earlier, said Jeff Brown, an oil-demand analyst here, while growth in refined fuel consumption slowed to a crawl.
Mr. Birol said that artificial energy shortages caused by distorted prices were the most likely basis for the curtailed availability of fuel, especially diesel.
But while diesel-fuel shortages and lines of trucks at empty service stations were a visible problem in China in April, they were not evident during trips over the last three weeks through southern China and to Beijing, and there has been little talk of continuing shortages in news media on the mainland or in Hong Kong.
When told this, Mr. Birol said there had been a vigorous debate in the last two days within the International Energy Agency over how to explain the decline in Chinese consumption, and he acknowledged that other, longer-term explanations were possible.
These include the possibility that the overall Chinese economy is starting to slow, that China is generating more of its electricity from coal instead of oil, and that China is improving energy conservation in response to high prices.
Economic statistics have been contradictory. Exports are still growing rapidly. But energy-intensive production of steel, cement and other construction material has started to slow as the government cracked down on real estate speculation.
In the last year, China has considerably expanded the production capacity of its coal mines and, just as important, the capacity of its railroad system to haul coal to markets. It has also exhorted businesses and households to use less energy, through steps like setting thermostats higher so air-conditioning systems do not have to work as hard.
Plight of Chinaâs investors
By Michael Pettis
Published: July 13 2005 19:49 | Last updated: July 13 2005 19:49
Chinaâs State Council is considering whether to set up a $12bn stabilisation fund to support the mainland stock markets, which are now 50 per cent lower than their highs in 2001. Although the fund is to be modelled on Hong Kongâs 1998 bail-out of its stock market, conditions are too dissimilar for the new fund to succeed. Its only effect will be to set back the development of mainland stock markets.
Although some economists argue that all government bail-outs distort the marketâs long-term ability to _allocate capital efficiently, interventions can at times be useful and even necessary.
A stable market is one in which investors buy and sell assets based on their perceptions of value, which automatically counteracts random price movements. âBuy low, sell highâ is a stabilising investor strategy.
There are times, however, when trading strategies do the opposite. When investors are highly leveraged, rising prices increase the ability of investors to borrow more, and so increase their purchasing power. Not all investors use this purchasing power but some do, and the net effect is that rising prices can lead to further buying, which will cause prices to rise further.
In a declining market, these investors suffer from margin calls as the value of their assets fall. In such cases, they may be unable to meet margin calls and the banks holding their assets are forced to sell part of the position. Falling markets, in this case, unleash selling, which causes markets to decline even further. In extreme cases, excess leverage can create bubbles on the way up and financial collapses on the way down.
Derivative instruments also implicitly involve leverage and so can also create the same destabilising trading strategies. In addition, those who hedge their positions engage in similar self-reinforcing behaviour. Their hedging strategies require them to sell when prices decline and buy when prices rise.
When markets are so heavily leveraged and derivative positions are so high that falling prices and forced _selling are heavily intertwined, a _market fall can quickly lead to a collapse, in which case it may make sense for financial authorities to intervene. _Government intervention acts as a floor that stops the price decline and allows traders to adjust without more forced selling.
Hong Kong in 1998 was suffering from such a condition. There was a real risk that if new buyers did not quickly emerge to purchase undervalued assets, falling prices could feed on themselves into a market collapse. By creating a buy-out fund as the investor of last resort, the Hong Kong authorities broke the mechanism that forced price declines and, in a short time, after traders and investors finally adjusted to the new price levels, the normal stabilising investor behaviour drove prices back up to more reasonable levels, allowing the government to exit with a handy profit.
These are not the conditions that characterise the mainland markets today. In China, prices have been falling for four years largely because excessive liquidity and weak policies drove markets to unsustainably high levels in the late 1990s. Even after four years of decline, average price-to-earning ratios of around 18 â compared with 15 in Hong Kong and 8 in South Korea â make it hard to argue that mainland markets are seriously undervalued. Furthermore, there is no evidence that highly leveraged investors and large derivative positions have trapped investors into self-reinforced selling to the point where they need a buyer of last resort. Prices are falling simply because they are not justified by the expected profits and high governance risks associated with listed companies.
A buy-out fund would make matters worse. The beneficiaries of the fund would not be the thousands of efficient and productive companies in China that desperately need a well-functioning capital market to grow. On the contrary, they would have to wait longer for help. The real beneficiaries would be inefficient and, at times, foolish investors and securities firms that have found themselves caught with overvalued stocks and are desperate to find an even more foolish buyer to take them out.
This is not the role the government should play, and it will not be profitable for China. The bail-out fund would only postpone the necessary price adjustments and ensure that China, like Japan in the 1990s, will draw out its agony over an even longer period.
The writer is professor of finance at the Guanghua School of Management, Peking University
By Michael Pettis
Published: July 13 2005 19:49 | Last updated: July 13 2005 19:49
Chinaâs State Council is considering whether to set up a $12bn stabilisation fund to support the mainland stock markets, which are now 50 per cent lower than their highs in 2001. Although the fund is to be modelled on Hong Kongâs 1998 bail-out of its stock market, conditions are too dissimilar for the new fund to succeed. Its only effect will be to set back the development of mainland stock markets.
Although some economists argue that all government bail-outs distort the marketâs long-term ability to _allocate capital efficiently, interventions can at times be useful and even necessary.
A stable market is one in which investors buy and sell assets based on their perceptions of value, which automatically counteracts random price movements. âBuy low, sell highâ is a stabilising investor strategy.
There are times, however, when trading strategies do the opposite. When investors are highly leveraged, rising prices increase the ability of investors to borrow more, and so increase their purchasing power. Not all investors use this purchasing power but some do, and the net effect is that rising prices can lead to further buying, which will cause prices to rise further.
In a declining market, these investors suffer from margin calls as the value of their assets fall. In such cases, they may be unable to meet margin calls and the banks holding their assets are forced to sell part of the position. Falling markets, in this case, unleash selling, which causes markets to decline even further. In extreme cases, excess leverage can create bubbles on the way up and financial collapses on the way down.
Derivative instruments also implicitly involve leverage and so can also create the same destabilising trading strategies. In addition, those who hedge their positions engage in similar self-reinforcing behaviour. Their hedging strategies require them to sell when prices decline and buy when prices rise.
When markets are so heavily leveraged and derivative positions are so high that falling prices and forced _selling are heavily intertwined, a _market fall can quickly lead to a collapse, in which case it may make sense for financial authorities to intervene. _Government intervention acts as a floor that stops the price decline and allows traders to adjust without more forced selling.
Hong Kong in 1998 was suffering from such a condition. There was a real risk that if new buyers did not quickly emerge to purchase undervalued assets, falling prices could feed on themselves into a market collapse. By creating a buy-out fund as the investor of last resort, the Hong Kong authorities broke the mechanism that forced price declines and, in a short time, after traders and investors finally adjusted to the new price levels, the normal stabilising investor behaviour drove prices back up to more reasonable levels, allowing the government to exit with a handy profit.
These are not the conditions that characterise the mainland markets today. In China, prices have been falling for four years largely because excessive liquidity and weak policies drove markets to unsustainably high levels in the late 1990s. Even after four years of decline, average price-to-earning ratios of around 18 â compared with 15 in Hong Kong and 8 in South Korea â make it hard to argue that mainland markets are seriously undervalued. Furthermore, there is no evidence that highly leveraged investors and large derivative positions have trapped investors into self-reinforced selling to the point where they need a buyer of last resort. Prices are falling simply because they are not justified by the expected profits and high governance risks associated with listed companies.
A buy-out fund would make matters worse. The beneficiaries of the fund would not be the thousands of efficient and productive companies in China that desperately need a well-functioning capital market to grow. On the contrary, they would have to wait longer for help. The real beneficiaries would be inefficient and, at times, foolish investors and securities firms that have found themselves caught with overvalued stocks and are desperate to find an even more foolish buyer to take them out.
This is not the role the government should play, and it will not be profitable for China. The bail-out fund would only postpone the necessary price adjustments and ensure that China, like Japan in the 1990s, will draw out its agony over an even longer period.
The writer is professor of finance at the Guanghua School of Management, Peking University