China's crazy bull market needs to be tamed
Hu Shuli warns of the dangers of the current A-share surge, and calls on Beijing to speed up changes to safeguard rational behaviour
Chinese leaders' pledge, at last week's Central Economic Work Conference, to strengthen risk control could not be more timely, given the frenzied exuberance in the stock market.
In a statement released after three days of meetings, leaders took note of the "variety of hidden risks" that had emerged alongside the economic slowdown. "The risks can be managed on the whole, but eradicating all of them might take a long time," they said. "We should treat both the symptoms and root causes, and find suitable remedies to the problems."
Regulators have pledged to closely monitor the development of financial and economic risks and, where needed, to deploy firm and targeted measures in response.
No doubt the prevention of systemic risks is high on decision-makers' agenda. And that must include averting the dangers of a "crazy bull" market.
For several months now, the stock market has been enjoying a rally it has not seen since 2009, in terms of both price and volume transaction. A stock rally is part and parcel of a capital market's healthy development. It is to be welcomed, particularly as China's stock market has long struggled to raise the funds needed to improve corporate governance.
However, a bull market should be an accurate reflection of investor expectations of future growth. That's not the case here. The price-to-earnings ratios for the stock of some small companies are already too high, while the high turnovers in the markets for coal, steel and non-ferrous metal have raised the eyebrows of some market insiders. Investor behaviour is becoming increasingly irrational.
All kinds of theories have been offered to explain the current rally: it's a revaluation; a consequence of reforms finally biting; even a result of Sino-US competition. One extreme but familiar view is that the Chinese stock market is so special that prices need no support from a company's fundamentals. Faced with such confused thinking, it's hard to agree with the simple-minded analysis that the Chinese stock market is poised to enter a golden decade. Instead, we argue that no healthy development can be possible without reforms.
The rally was the result of huge amounts of cash being injected into the market: some through margin trading and total swap returns by brokerage firms, and some via trust companies and the massive wealth funds managed by banks. In addition, the government kept interest rates low.
Although the debt-equity ratio in the domestic market isn't high, the speed and size of the incoming flood have increased the risks of a bubble developing. No matter which way the market goes next, the regulators must remain alert.
How did this huge amount of cash become available? One reason is the government's eye-popping investment spree a few years ago. These government projects tended to be insensitive to market conditions. So, given the fevered property market, the market interest rates could not adjust as they should.
Since the beginning of this year, property investments have turned south, while local governments have also been told to rein in their investments. If the economy does not perform as well as expected in the coming year, and business profits continue to slide, we can expect the bull market to come to an abrupt end.
Notably, the A-share market today is markedly changed from the one that saw similar bull runs in the past. The professional investors have become more agile and have access to more effective leverage tools. This means they are much quicker in moving funds into the market when the conditions are right, and moving them out at the slightest whiff of a rumour. Such volatility makes a market crash more likely, of course. By contrast, the characteristics of China's retail investors have not changed much. So, in the event of a catastrophic crash, the adverse impact on society is likely to be that much greater.
The rational support for a bull market should be the expected dividends of China's reform drive. Since their third plenum a year ago, Chinese leaders have either pledged, initiated or accelerated a plethora of reforms, including financial reforms such as the liberalisation of interest rates and the internationalisation of the renminbi, as well as related reforms in state-owned companies and land.
The progress is admittedly slow, and it will be some time before China can truly reap the dividends of change.
In the A-share market itself, some changes are long overdue, including those of the listing application and rules for delisting. With no progress on this front, investors will be understandably nervous. The China Securities Regulatory Commission is expected to begin public consultations for listing reform next year.
A wildly fluctuating, crazy bull market is detrimental to China's reform push. While regulators should refrain from direct intervention, it is their duty to disclose the risks for investors.
