My Blog

April 25, 2008

This is exactly what I was worried about.  After a strong start this morning on the back or yesterday’s furious rally the Shanghai and Shenzhen stock markets suddenly turned negative and ended the day lower, with the SCI dropping by 0.71%.  It is widely known among financial market experts that governments can have powerful impacts on the market by signaling their intentions, but the more often they do it by pure signaling (i.e. with measures that have no fundamental impact) the less credible their signaling becomes over time.  In other words the more you intervene to control the market the more empty your intervention becomes – this is a weapon whose greatest power lies in the rarity with which it is used. 

I suspect we may be about to prove this yet again.  For the past year we have seen a whole series of interventions designed explicitly to manage market prices – and although they have worked well, they have done so with decreasing success.  The market surged 9.3% yesterday when the tax authorities announced that they were cutting the stamp tax, but everybody bought just because they expected everyone else to buy.  There was no real conviction.  

And since the announcement provided no real change in the earning prospects for Chinese companies, savvy investors seem to have taken advantage of the event to shift their shares into the hands of the more gullible.  China Daily today quotes a man who trades stock at a Shanghai broker saying, in the midst of yesterday’s rally “I bet the market would undergo a strong rebound before the Olympics, and I will exit the stock market forever if I can make any gains then.  It is just too risky for ordinary people like me.”  He is probably unhappier than ever today.  If this kind of opinion is widespread, and I think it is, it bodes badly for the longer-term development of the stock markets.

How aware are the authorities of the risks of this kind of intervention?  The always astute Li Xinxin at Observatory Group wrote yesterday about the reasons for the stamp tax cut – a decision that he worries about no less than I do.

The new cabinet, especially Vice‐Premier Wang, once intended to reinstitute the non-intervention principle for China’s capital market, but their effort failed.  In recent weeks, there was an intense debate among both policymakers and scholars about whether the government should rescue the stock market.  Wang preferred not to use the trading tax rate to micromanage equity prices, but his opponents used the social stability argument as a major reason for such a decision.  This is a critically strong argument in an Olympic year, and particularly when top leaders already are stretched by challenging issues such as Tibet and inflation.  

The government has performed particularly poorly in public communications. Vice Premier Wang and his team had a good chance to establish new criteria for government intervention by expressing their views and guiding market expectations. But no government officials dared say anything on this issue, reflecting a very rigid political system.  That silence gave the impression that the government made a major concession to market pressures in return for nothing. 

With this tax rate cut, the government reversed an 11-month-old tax increase and reinforced the policy-driven feature of China’s stock markets.  Certainly, the constant change of market rules does not help build a well-functioning market which could efficiently distribute financial resources in the long run.  In this sense, the new cabinet is not different from its predecessor.  

It will be interesting to see what happens to prices next week.  My assistant Shang Ning tells me that there are rumors that the big buyers who pushed prices up prior to the announcement of the cut in stamp tax were the local pension funds.  I have no idea if this is true, but they do tend to have better access to information than the rest of us do, and clearly someone either very lucky or with very good information sources was buying the market if it traded up 4.2% after so many weeks of decline.  

If many small investors really do expect a pre-Olympic rally that lets them out of their losing positions, I am afraid this is going to result in another disappointment.  Still, maybe the government has a few more tricks up its sleeves.  I think 3000 is widely considered to be the minimum level below which the government acts.  Call it the “3000 put”?

In June 1999 I remember that Paul Krugman wrote a note on the implicit euro “put” that existed because for purely symbolic reasons European authorities were loathe to let the euro trade below $1 (how long ago that seems!).  His conclusion, reached by an elegant application of option theory (you can find the note at http://web.mit.edu/krugman/www/hershey.html), was that when the euro finally broke $1, it would break big.  It did.  Perhaps this has nothing to do with the Shanghai markets, but if the “3000 put” really does exist, it might have.

Comments (4) for "Stock market is down today"

I do not think that day-to-day change in stock market, except the big day like 9%, means anything here. If there is a question about stock market, what is the next industry/sector to rally like ag and agchem? By fatbrick - 4/24/2008 9:22 PM

Day by day market fluctuations do not reveal trends, and if we miss the trends we miss the accurate forecast. The trend in China's market is bearish; a fifty percent correction is impossible to dismiss. Despite robust GDP growth, investors are selling, because the 'tea leaves' portend future unemployment as the only cure for the steady surge in Chinese inflation since last December. As the slowly appreciating Yuan begins to create American resistance to buying Chinese goods, some kind of economic contraction is bound to occur, even if only to shift resources. How many unemployed in China if GDP growth contracts to 6%, or 3%? The stock market does not know, but its 50% drop is a serious attempt to find out by bringing values down. By a Duoist - 4/25/2008 5:29 AM

When your rulers are engineers, I suppose it should come as no surprise when they try to engineer. The middle of last year I recall was a funny time because high officials would try to talk down the market, then when it sank too much, they'd try to talk it up, then when it rose too much, they'd try to talk it down. I'd be very wary of investing in Chinese A shares, even if I could. The floats for a lot of the big companies are small, disenfranchising outside investors (ICBC is what, 30% publicly traded? So it's market value is largely hypothetical.) The majority owner in these big public companies is the government which has its own agenda that clearly doesn't always align with that of investors. There is a lot of money on the sidelines (in bank accounts) that can fuel bubbles, with immature investors behind it. People are looking to the government for which way the market could go, which is I suspect doubly inefficient: inefficient for the obvious reason that rational factors don't drive stocks the way they should but also inefficient because of the degree to which it scares off rational investors who would bring more efficiency to the market. The first step to sorting out this mess, I agree, seems to be to step back and let the capital markets do what they will and stop meddling. But I think there may be subtle reasons why this is hard to do, owing to politics and culture and the way the government has conflated its image with that of the great nation of China and so on. By Chinawatcher - 4/25/2008 8:55 AM

Having the CSI down by some 50% since the top last Oct, or giving back some 61% of the total gain since June 2005 makes the index as oversold as it gets. To see the index up by 9.3% on Thursday with significantly higher trading volume reflects deep oversold condition. Friday's close was not ideal, but an optimist may rightfully claims that's expected on a friday afternoon immediately after a 3-day 20% increase from the low. The intraday cumulative up-down volume closed the day in positive territory even though the index itself closed down 0.7% so there is still hope for more upside. It would have been nice if the index had close up and above the high of April 8, making it a higher high, but there is still hope the index may not make a lower low below 2990 on Apr22. By Kheng - 4/25/2008 7:18 PM