Asia dispatch: Lack of real choice continues to fuel markets

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If there is one good thing to come from the collapse in the mainland Chinese equity market over the past six months, it is that no one asks for stock tips any more.

Just a year ago, big cities such as Beijing and Shanghai were in the throes of a stock market frenzy.

It was almost impossible to get through a lunch or dinner without someone talking about a relative who had made millions in just a few months. Everyone seemed to have a friend who knew someone who knew someone who knew of a sure bet.

The market-fever was so great that employment agencies for ayis, domestic helpers, complained they could not find enough people to do the jobs because too many were trading shares instead.

Pawn shops said that people were willing to exchange the deeds to their houses in return for money to invest in the market.

A colleague used to come in every day with a new word he had learnt for investing behaviour – “ghost shares” were highly risky stocks, while “black horses” had beaten expectations.

A friend recalls her tai chi class being brought to an abrupt halt because the teacher wanted to get to his brokerage before the market opened. Heady days in a market that surged from just above 1,000 points at one stage in 2005 to above 6,000 points last autumn.

And then the market did what most markets that have risen so quickly do – it collapsed. This month it fell through 3,000 points to groans of pessimism on all sides – even though that is still a nice return if you happened to buy at the bottom.

The downward slump has taken several phases.

First, it flushed out a lot of the more speculative retail money, the day-traders who had been thronging to local brokerage halls. Yet at first there was no rush to withdraw money from the country’s new mutual funds, which suggested the declining market was at least becoming more professional.

However, now those fund mangers are also being blamed for joining in the panic-selling. Some observers point out that the new generation of Chinese money-managers is young and inexperienced.

According to one research report a few months ago, the age of the average fund manager in China is 35, against 45 in more developed markets, while a third of the people managing funds have less than one year’s experience.

“Perhaps investors should take a step back and take a long hard look at who these managers are and what is motivating their headlong dash for the exits,” suggests Steven Sun, analyst at HSBC in Hong Kong.

The overall China economic story has not lost any of its lustre, even with an outburst of inflation at home and a slowdown in the US, so there is a huge amount of interest in taking a position in the Chinese market once it reaches a more sensible level.

Yet the problem is that it is not much easier at 3,000 points than it was at 6,000 points to say what a rational level is for mainland shares. Even after the learning process of the latest boom, many investors are no clearer about how to make money in the mainland market.

The normal valuation metrics just do not apply to China. The Chinese companies that are listed on the Hong Kong market have to compete for the attention of international investors just like everyone else, so to win a valuation ahead of their peers, they need to demonstrate superior performance.

Back in the mainland market, however, there is much less competition for capital because of restrictions on taking money out of the country. Investors have few choices about what to do with their money – keep it in the bank earning a negative rate of real interest, invest it in property markets that are looking shaky in a number of cities – or put it into equities.

Given these restrictions, the market has been driven not by estimates about what companies are really worth, but by the vast flows of liquidity from the banking system – where individual investors have $2,000bn of savings – into stocks.

The level of bank deposits tells the story of the market boom: they dropped sharply in the middle of last year, when share prices were soaring, and rebounded from the end of last year, when the rot set in on the market and money returned to the banks.

The market remains trapped in boom and bust cycles driven by the mood of bank depositors.

Given such erratic movements, professional investors are scrambling around for strategies to try to pick winners.

Not everyone has abandoned looking at earnings multiples but what to make of company results when so much of the profits last year came from investing in the stockmarket?

Others still believe that the best way to choose stocks is to have good contacts in the Beijing bureaucracy who can provide guidance on new policy pronouncements.

Some more sophisticated institutions believe the trick is to invest in smaller companies run by entrepreneur owners that are not affected by the whims of bureaucrats.

Yet finding such companies requires painstaking and time-consuming research and often requires betting on untried managers. China’s double-digit growth is unrelenting but it is no sure bet for investors.

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