Chinese stocks, red chips and global financial markets

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By Andy Scott

SHANGHAI, Mar. 6 – Asian stocks are rallying for the first time in five days, stemming a worldwide sell-off that wiped US$1.5 trillion from the value of global shares.

The downward trend began last Tuesday when the Shanghai stock market dropped over 9 percent. Other Asian markets began to tumble and by the end of the week the European and American markets where in decline as well, leading many to look at China as the cause for the general downturn.

But China’s fall cannot be blamed for the global re-positioning of markets. As The New York Times reported, many economists and strategists predicted that volatility could increase sharply in Asian markets as investors pull back from speculative investments and redirect assets to more mature markets, and as other investors look for buying opportunities.

On Monday, Shang Fulin, chairman of the China Securities Regulatory Commission (CSRC), announced that China’s stock decline was a normal fluctuation and wasn’t responsible for last week’s global market route. China’s stock market was still immature Shang said without elaboration at the first day of the meeting of the National People’s Congress in Beijing.

Concerns over the Chinese government’s crackdown on loans to finance share investments dragged the Shanghai and Shenzhen 300, tracking yuan-dominated A shares listed on the nation’s two stock exchanges, down 6.3 percent last week. The benchmark closed at a record on February 26 before dropping 9.2 percent on February 27. The current market is still more than double its value a year ago.

Big sell-offs in Asia and modest declines in Europe on Monday preceded a downturn on Wall Street in the United States, but analysts said that while the sell-off of assets considered risky was likely to continue for some days, the decline was probably not a sign of a recession and unlikely to set one off.

“This is the way corrections work,” said Garry Evans, a strategist with HSBC in Hong Kong to The New York Tiimes. “A week ago, everyone was very excited about the markets and now no one wants to buy stocks.”

In the midst of all this, the Shanghai Stock Exchange announced that its number one priority in 2007 was to create a top-notch blue-chip market by luring more quality listings and boosting liquidity. To bolster the quality of listings, the exchange plans to allow, for the first time, Hong Kong-incorporated Chinese mainland firms to list in Shanghai by the end of the year.

“We will work actively to ensure the market’s safety and beef up technical innovation,” the exchange stated. “Additional efforts will be made to educate and test new systems to curb risks.”

Our own Senior Partner, Chris Devonshire-Ellis, also commented: “China’s Security & Regulatory Commission, responsible for safeguarding the credibility of Chinese plays actually has no mandate for levying punishments on errant companies. As a regulatory body, they essentially have no teeth and can only make recommendations. Those then can run foul of other vested interests.

“I also note the reporting of non-existent assets – such as the entire value of a JV (and not just the Chinese equity) being listed in mandates when applying for listings in Hong Kong, means some red chips there are grossly inflated in terms of their actual assets. It is significant that the Hong Kong bourse is finally waking up to this and the decline of share values in Hong Kong has affected red chips the most. It is about time for the China and Hong Kong markets when dealing with PRC plays to start to weed out the weak – meaning casualties may well follow.

“This can only be a good thing longer term, and if it is not triggered now–it will be at a later date. However comments elsewhere that China plays are of significant strength to impact much on global markets I feel are misplaced and are being used as a scapegoat to cover inherent fundamental weaknesses in other economies, and in particular the United States.”

The meteoric rise of the Shanghai Stock Exchange to record highs following the Chinese New Year, and subsequent fall reflects the immaturity and high-risk of its current listings. As China moves to strengthen its exchange, investors will most likely turn to more secure stocks elsewhere in Asia. As Bloomberg reported, “nothing has actually changed for shares fundamentally, and you’re going to get more investors buying stocks once they’re confident that the slump was a temporary event.”