Sunday, 20 May 2007

Who is REALLY inflating the "Chinese Stockmarket Bubble"?

As Chinese share prices resume their relentless rise the Friday's FT presented an excellent piece entitled:

Elusive drive share-dealing boom

I admit that on this blog I have tended to emphasise the burgeoning number of retail/small shareholders and have quoted the oft cited statistics that "the Chinese have been opening 300,000 share trading accounts a day, taking the total number to 80 million".

Whilst these are still very large numbers and are certainly not helping the situation, the FT is correct to point the finger in another direction. Given my recent investigations into business practice in China, a lot of this makes sense. Moreover, it suggests that the fall out from any bursting of the bubble may be more serious that I had originally envisaged.

The hypothesis expounded in the article is that a large percentage of the free float (shares available for public purchase) have been bought, not be small individuals, but by state owned enterprises, the army and unregulated private funds. Now the fall out from any potentially large losses begin to look at little more scary.

I have included only selected paragraphs. My "bold" highlights.

If there is a symbol of China's stock market boom, it is the novice retail investors who have rapidly developed a passion for equities. Brokerage offices that were almost empty a year ago are now packed with young and old would-be speculators. In recent weeks, the Chinese have been opening about 300,000 new stock trading accounts every day, taking the total number of accounts to more than 80m.

But who is really driving the Chinese market, which has quadrupled in value in two years? The new retail investors have captured the headlines, yet some market-watchers believe they are just one part of a much broader surge in stock-buying, which contains the seeds of potentially big problems for the government.

According to a provocative new analysis from Fraser Howie, an investment banker and author of a book on China's stock markets, the role of retail investors has been exaggerated. Instead, Mr Howie says, around $225bn (£113bn) of shares - or nearly half the float - are owned by less conventional fund managers.

He believes a significant chunk of shares has been bought over the last year by different parts of the government, such as state-owned companies, local government units, the police and the army. Such investments are impossible to prove but he argues the same thing happened during the last bull market, which ended in 2001, and that accountability of government spending at local level remains weak.

Some of his impressions are supported by other investors. "It was the big, cash-rich state-owned enterprises, particularly the tobacco companies, that were the main drivers of the market until the end of last year," says Chris Ruffle, co-chairman of MC China, a subsidiary of Martin Currie Investment Management and a large investor in China. "They have so much money they don't know what to do with it, so they put it in the stock market."

Another significant slice of new money has come into the market from the hundreds of new private investment funds that have sprung up over the last two years, often run by individuals who invest the money of friends and family. In China they are often referred to as hedge funds because they are not regulated, and they usually call themselves "investment consultants". They are gradually becoming a powerful force in the market. Mr Howie reckons these funds could have $50bn under management, while other estimates go as high as $75bn.


"The market is not being driven by accounts held by old ladies or farmers from Guangxi," he says.

While the real ownership of the stock market is impossible to pin down, Mr Howie's analysis poses important questions about what might happen if there is a sharp crash in share prices. The losers would not just be the small, retail investors who piled into the market when it was already relatively expensive. they could also include government organs and state-owned companies.

With speculation mounting that the government will seek to burst a perceived bubble in the market, such investments would add to the complicated vested interests the authorities face.

"I would hate to be the market regulator at the moment," says Mr Howie.

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