The stock market bounced around again Friday before the SSE Composite closed trading at 2294, for a loss over the day of 0.2%. No one in the market seems to have a clear idea or much conviction. The real news, however, was the announcement that the State Council had approved the CSRC’s plan to permit short selling and margin lending. The details aren’t fully available, and I haven’t been able to find, if it has been published, the marginable amount, but the regulators are betting that these new mechanisms are more likely to spur net buying than net selling, and so will provide support to the market.
If there were a large group of fundamental investors and relative value traders in the market, I would agree that increasing flexibility and the use of hedge instruments would widen market activity and ultimately reduce volatility. It seems to me, however, that without better corporate and macroeconomic disclosure, clearer and enforceable rules on governance, a stable regulatory framework and a sharp reduction of the government’s tendency to try to micro-manage market movements, the market will continue to be dominated by speculative investing. In a speculative market, short-selling and margin trading will only increase volatility.
New trading tools will not change investor behavior as“ they will only either reinforce or dissipate it, and in this case I suspect it is likely to be the former. I remember in 2003 I debated with an official at the Shanghai Stock Exchange about whether or not the introduction of sophisticated foreign investors through the QFII mechanism would transform the Chinese stock markets and make them far more efficient at capital allocation. He thought it would, but I argued that investors were not value investors or speculators according to their genetic makeup.
What matters, I believe, were the types of activities that the structure of the market permitted, and it seemed to me in China there were few tools available to fundamental investors (consistent information, strict governance, stable “rules of the game”) and a huge number of tools available to speculators (i.e. non-economic and technical factors that affect short-term changes in supply or demand, including, of course, the tendency of the government to signal or intervene in the market). I concluded by saying something that I have seen repeated a lot since then as “In China even Warren Buffet would be a speculator.”
The person I was debating with was very polite and agreed that my characterization of the â€œoldâ€ market was entirely accurate, but he claimed that Chinese markets were speculative largely because Chinese investors were unsophisticated (a claim about which I was and am very skeptical), and that QFIIs would dramatically change that. In two to three years, he thought, I would radically change my opinion of the efficiency and stability of the market.
Needless to say that hasn’t happened. I am fully convinced that the structure of the investor base will not change to include a better balance of fundamental and relative value investors, and not just speculators, until the underlying problems that make fundamental investing in China impossible are remedied. These include a lack of accurate and consistent data, very weak and arbitrary corporate governance, and no stable set of rules, among other things.
Until then, changing the tools available to investors will only either exacerbate the power of speculative behavior or dissipate it. It will not change speculators into fundamental investors. Short selling and margin trading only add to their firepower. My prediction? Expect volatility to rise in the next few months, not decline. Mind you, after jumping nearly 30% from its lows just 1 1/2 weeks ago, the SSE Composite is now where it was less than four weeks ago. That should be more than enough volatility for any normal person.
On a separate topic, I think there will be a lot of interest in seeing the new reserve numbers. We only get the information on a quarterly basis now (monthly data used regularly to be leaked, but not any more, it seems), so October should get us 3rd quarter data. Needless to say I am very interested in seeing if the”unexplained” changes as “ usually a proxy for speculative flows“ will make a big difference. If we see outflows it will certainly affect how willing policy makers will be to loosen monetary policy.