Investors along with analysts are responding in kind, paying great attention to the fundamentals of China plays in the Shanghai and Shenzhen markets, where the movements in those stock markets have little if any relevance to the movements of stocks globally. With 90% of the market owned by one institution, it is difficult to justify their global influence, says Devonshire-Ellis.
Devonshire-Ellis spent two decades living and working in China representing organizations involved with direct foreign investments (FDI), before relocating to Mumbai this year to manage Dezan Shira’s India practice.
Investors and analysts need to distinguish between hype and reality, he adds. Consider the following as a primer.
China’s experiment with stock markets began in the early 1990’s, when two bourses were established, in Shanghai, and in Shenzhen, the booming border city next to Hong Kong. However, should we wish to take the credibility of these markets seriously, we should understand the very nature of them well. Many people, analysts included, make too many assumptions about the nature of these markets. The actual background to them marks them out as completely different animals to the usual understanding of what a globally quoted stock market looks like.
First, the characters of these markets are completely different. Neither has any foreign companies listed. That means that despite all the foreign investment that has poured into China during the past two decades, none of these companies are quoted as stocks on the Shanghai or Shenzhen exchanges. Foreign Direct Investment (FDI) in China hit US $92.4 billion in 2008 alone, yet none of that money or investment is permitted to seek additional funds on the mainland. There are moves afoot to liberalize the markets to include the listing of subsidiaries of foreign multinationals, but to date access to domestic Chinese financing is off limits to foreign investors. Shanghai and Shenzhen contain no foreign company listings.
Accordingly, the stocks traded in China are purely domestic mainland Chinese companies. But here’s another catch – a staggering 90% of them are ultimately state-owned enterprises. Investing in the China stock market therefore is skewed by massive China government involvement. However, even here the market is obscure. Stocks made available to the Chinese public and publicly traded are priced at a different level to those non-tradable stocks still held by the state owned enterprise. Denominated as tradable and non-tradable “A” shares, tradable A shares have their price set by the market, whereas non-tradable shares are considered “institutional”
This has created additional problems should a state owned enterprise wish to raise more money on the stock exchanges by issuing more shares. State owned, non-tradable shares are usually priced at a higher value than traded shares. But releasing more shares onto the market often influences the sentiment, driving the price down, and leaving the state owned enterprise with a loss on the transaction when converting non-tradable stock to tradable stock.
The China markets additionally provide “B” shares – stocks of Chinese listed companies that are traded in foreign currency. Confusingly, these are denominated in US dollars in Shanghai, and in Hong Kong dollars in Shenzhen. Some companies are quoted in both A shares and B shares. This means that even currency movements against the RMB can affect the inherent value of China’s shares.
Working out the fundamentals then when evaluating the movements of China’s shares should therefore mean attention being paid to a number of influential factors:
1) Local Market Sentiment (traded A shares)
2) The Government Valuation (non-traded A shares)
3) Foreign Currency movements against the RMB, Hong Kong dollar and US dollar
4) Potential for Government Influence
5) Understanding that the markets do not reflect the value of any foreign investment in China
Most markets that analysts would evaluate (and even then they often get it wrong) would base fundamentals just on the first item, let alone a further four influencing factors. The mainland Chinese stock markets are not structurally related to any overseas markets of which I am aware.
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