China Seeks to Restore Stock Investors’ Vanished Trust

Carrie Pan, a 29-year-old Shanghai accountant who’s lost almost half the value of her portfolio since she began investing in Chinese stocks, is confident again.

She purchased 1,000 shares of Yang Quan Coal Industry Group Co. in April to add to her 200,000 yuan ($31,400) in equity holdings, which fell 40 percent last year and compounded her losses since she started buying stocks six years ago. So far, her latest pick had been up about 4 percent through yesterday.

“I believe stocks will rise,” said Pan, watching her holdings on a computer screen in her two-bedroom apartment and sipping a mouthful of bottled Ice Dew spring water on a recent afternoon of maternity leave. “Guo has already done lots of things to support the stock market since he took office, and he is very keen on improving the market’s performance.”

That would be Guo Shuqing, the 56-year-old head of the China Securities Regulatory Commission, who took over seven months ago pledging reforms. Since then, Guo has taken action to increase the amount of stocks foreign investors can buy in the otherwise-closed market, urged listed companies to pay more cash dividends to shareholders and made changes in how initial public offerings are priced.

“Our current stage of work is focused on improving the fair play of the market, protecting investors’ legal rights and enhancing the ability of serving the real economy,” Guo said in a People’s Daily report posted on the securities regulator’s website in March. “We’ll bring more market forces to gauge to- be-listed companies, reveal their potential risks and let more investors oversee pricing.”

The CSRC and the country’s two exchanges, in Shanghai and Shenzhen, have also announced plans to cut transaction costs for stock purchases and sales, and tightened accounting scrutiny on companies that are facing delisting.

Restoring Trust

The goal is to restore the vanished trust of a Chinese public that has taken a walloping in stocks and instead sought investment alternatives such as bubble-prone real estate and the world of underground lending, known as shadow banking, where risky and unregulated investments promise investors annual returns of as much as 100 percent.

“Guo is the man,” said Hao Hong, chief China strategist at BoCom International Holdings Co. in Hong Kong. “It’s a show of determination. It’s all about confidence building.”

Like Pan, millions of Chinese investors watched their stock investments crash and remain mired in a two-year bear market. The benchmark Shanghai Composite Index (SHCOMP), after peaking at 6,092 in 2007 following a bull market, fell to just above 1,700 by the end of 2008. Four trillion yuan of government stimulus lifted the index to 3,471 in 2009. Yet the market fell another 33 percent in 2010 through 2011, dragging valuations to a record low of 8.9 times estimated profit in January.

Losing Their Shirts

The Shanghai index is up 5 percent in 2012, though it has fallen 6.1 percent from this year’s high on March 2 amid concern an economic slowdown is deepening. The gauge dropped 0.1 percent to 2,309.56 today.

China’s 50 million individual investors lost an average of 40,000 yuan last year, according to a May 9 People’s Daily report. That’s almost twice the annual average disposable income of an urban Chinese. Those returns, exacerbated by IPO prices that tanked immediately after listing, companies’ reluctance to pay dividends, and speculative bets on smaller companies’ back- door listings, contributed to equity flight.

Insider trading probes have also kept some investors away. The securities regulator handled 39 such cases in the first 11 months of last year, the CSRC said in a November statement. That’s compared with 42 in the first 10 months of 2010, it said. The focus on market oversight is still to prevent and crack down on insider trading, Guo said at a December forum in the southern city of Shenzhen.

Seeing Hope Again

Police detained a former fund manager at Bank of Communications Schroders Fund Management Co. and the former chief power analyst at Citic Securities Co., the nation’s biggest publicly traded brokerage, for insider trading, the CSRC said in statements on its website on May 23.

“Investors lost their confidence in the value of the market itself because they think this isn’t a market they can play in,” Wu Xuan, a Beijing-based strategist at Rising Securities Co., said in a telephone interview. “What the new CSRC chairman is doing with his new policies is to let investors see hope again.”

On average 3 million new investors enter the stock market every year while millions leave or stop trading after suffering heavy losses, a situation the regulator wants to curtail, the CSRC said in a statement in April, citing Guo, who was visiting the southern province of Guangdong at the time.

Charismatic Leader

Guo, while heading the State Administration of Foreign Exchange in 2001-2005, was known as a charismatic leader who handled relationships with other government departments to drum up support for reforms “with ease,” according to Hong Weizhi, a former SAFE spokesman who worked with Guo.

Also a former vice governor of the central bank and most recently chairman of China Construction Bank Corp. (601939), the nation’s second-largest lender by market value, Guo helped oversee the company’s $9.2 billion IPO in 2005. A fluent English speaker, Guo was a visiting scholar at Oxford University in 1986-1987.

“When he moves, he would follow one punch with another, with every punch hitting the right spot,” Hong, head of the financial affairs office at Kunming city in southwestern Yunnan province, said in an interview in Beijing. “That’s just his style, and he really knows what he’s doing. He’s done plenty of homework, having had a whole set of reform ideas in his mind since long ago.”

Stock Demand

Reviving demand for equities among investors is important in a market where individuals own 26.5 percent of the nation’s stocks, compared with 15.6 percent held by institutional investors and 57.9 percent by corporate holders, according to the CSRC’s investor protection bureau.

“The CSRC’s objective is to provide a fair and open market for investors,” said BoCom’s Hong. “All of Guo’s initiatives are working toward this goal.”

The property bubble that resulted from investors plunging into real estate as an alternative investment drove up home prices by as much as 140 percent since 1998, threatened social stability and prompted the government to increase down payments and mortgage rates for home purchases in the past two years to curb rising costs.

Home prices fell in a record 46 of 70 cities tracked by the government in April from a year earlier, according to the statistics bureau.

Deflating Bubbles

“Bubbles in the property market have yet to be fully deflated,” said BoCom’s Hong, a former global strategist at China International Capital Corp. who predicted the Shanghai Composite’s slump in 2010. “It’s likely that some of the funds may flow into the stock market from the property sector if the government continues to ease credit while keeping the curbs on home purchases.”

The government also wants to lure away money from the unregulated shadow-banking sector, valued at $2.4 trillion by Yao Wei, a Societe Generale SA economist, where investors have sought to beat an annual inflation rate that kept pace with or exceeded the 3.5 percent interest rate paid on savings bank deposits. Lawlessness associated with risky investments gone bad has led to scores of suicides, death sentences for those convicted of fraud, and pledges from Premier Wen Jiabao to bring shadow lending under government supervision.

Government policies have encouraged companies to seek funding from public offerings in order to reduce reliance on bank loans, which provide 72 percent of the nation’s credit.

Qualified Investors

To boost equity demand, the CSRC said on April 3 it would more than double the amount that overseas institutional investors are allowed to invest in Chinese securities to $80 billion, while the foreign-exchange regulator said May 20 that it will speed up the approval process.

Only approved institutional investors can buy or sell yuan- denominated securities under the qualified foreign institutional investor, or QFII, program. Regulators had approved a combined $26 billion in investments for 138 QFIIs as of May 8, according to SAFE’s statistics.

Increasing the quota is “providing a signal to the market of the government’s desire to expand the domestic market,” Mark Mobius, who oversees about $50 billion as executive chairman of Franklin Templeton’s Emerging Markets Group, wrote in an e-mail response to questions. “We do see some opportunities in the A- share market,” referring to yuan-denominated stocks trading on the Shanghai and Shenzhen bourses.

Excessive speculation in trading IPO shares and the stocks of small and under-performing companies remains “very serious” in China, distorting prices and hurting investors, the CSRC cited Guo as saying in an April 22 statement.

Frothy IPOs

The root cause for investors’ losses lies in “defects” with the mechanisms and systems of the capital market, which led to the high IPO valuations and speculation in underperforming companies, the securities watchdog said in a February statement.

Sinovel Wind Group Co. (601558), the country’s biggest maker of wind turbines, has tumbled 66 percent since it began trading on the Shanghai Stock Exchange in early 2011. The company offered 105 million shares at 48.8 times reported earnings, according to its IPO prospectus. That was three times the Shanghai Composite’s valuation at the time, according to data compiled by Bloomberg. Pang Da Automobile Trade Co. (601258), the nation’s biggest publicly traded car dealer, offered stock at 39.6 times reported profit in April last year. Its shares have slumped 51 percent since then.

Now at 9.97 times estimated earnings, the current Shanghai Composite valuation compares with the MSCI Emerging Markets Index’s multiple of 9.70.

Wider Criteria

In seeking to empower individuals, the CSRC will now invite as many as 10 retail investors to advise on IPO pricing, a process previously restricted to institutional investors. Companies need to openly analyze and discuss pricing if the price-to-earnings ratio of an IPO is expected to be 25 percent higher than that of publicly traded companies in the same industry, the CSRC said in an April 28 statement.

A day later, the Shanghai and Shenzhen stock exchanges introduced rules widening criteria for delisting companies. Companies with negative net asset values for two consecutive years will be removed from trading, while net income excluding one-time gains will be used as a benchmark for true profits for companies seeking to relist, the two bourses said in separate drafts seeking public comments.

The CSRC has announced that the Shanghai and Shenzhen exchanges would cut stock-trading fees by 25 percent effective June 1, a move Citigroup Inc. said will save investors 3 billion yuan annually.

Not Totally Convinced

“What Guo is dealing with are all the historical hangovers, and these things aren’t what can be tackled easily,” said Dai Ming, a fund manager at Shanghai Kingsun Investment Management & Consulting Co. “That’s definitely very helpful for the healthy long-term development of China’s capital market by improving the fundamental system.”

Not every investor is convinced. Alice Cheng, a 28-year-old marketing manager who dropped in on a Huaxi Securities Co. outlet in northeast Shanghai to talk with an investment adviser, says Guo’s efforts will take time. She won’t buy stocks until the Shanghai Composite rises above 3,000, a level signaling the start of a bull market to her.

“I do appreciate what Guo has done, but that won’t have an immediate effect on boosting stocks in the short term,” Cheng said. “China’s stock market is a very ailing patient that cannot recover overnight. All these measures are simply like treating the patient with traditional Chinese medicine, which is slow to take effect.”

Predicting Gains

Morgan Stanley Huaxin Securities Co. and Guotai Junan Securities Co., which correctly predicted the end of China’s last bear market in July 2010, said shares will probably rally as the government takes measures to bolster growth. Morgan Stanley Huaxin said in April the Shanghai Composite may rise another 30 percent this year.

Wang Hanfeng, Beijing Gao Hua Securities Co.’s China strategist, said last month the index could climb to 2,750 by year-end. Gao Hua is the most accurate brokerage for China A- share research based on Bloomberg Rankings.

China’s economy expanded 8.l percent in the first quarter, the slowest pace in almost three years. Premier Wen unveiled in March a 2012 growth target of 7.5 percent, down from an 8 percent objective in place since 2005. The People’s Bank of China cut banks’ reserve requirement ratios last month for the third time since November to boost liquidity.

More Dividends

“The message from recent government announcements with respect to the equity market is loud and clear,” Jiong Shao and Jing Yang, analysts at Macquarie Securities Ltd., wrote in a May 10 report. “The government wants the A-share market to be up.”

The securities regulator is also encouraging companies to increase dividend payouts to lure more investors in a nation where dividend yields, or the amount of cash companies return to shareholders as a percentage of stock prices, are the lowest among the world’s 10 biggest equity markets. The Shanghai Composite’s yield is 1.99 percent, according to data compiled by Bloomberg.

The CSRC said in November it would introduce measures to boost listed companies’ dividends to shareholders. The CSRC is urging publicly traded companies to seek comment on dividend payments from small shareholders and independent directors and write into corporate articles conditions for paying cash dividends and bonus stock, according to a May 9 statement. Companies seeking public listings should disclose their profit- distribution plan for the next three years, it said.

IPO Prices

Of the mainland’s 2,403 publicly traded companies, 67 percent proposed to pay cash dividends in their 2011 annual reports, an increase of 6 percentage points from a year earlier, the CSRC said on May 10. The dividend payout, or the cash dividend as a percentage of companies’ annual net incomes, rose just 1 percentage point, to 31 percent, in 2011 from the previous year, it said.

The CSRC’s moves have started to cool IPO excess. The average prices fell to an equivalent of about 20 times companies’ earnings in early April from a ratio of more than 30 times in the first quarter and 47 times last year, the watchdog said in an April 20 statement.

Increasingly, investors seem to be paying attention. Liu Xi, a 35-year-old hotel sales manager in Shanghai, said she plans to buy stocks once economic growth starts to rebound. Pan, the accountant, plans to increase her investment in stocks by 20 percent this year.

“I already have my money ready,” Pan said. “I’ll buy on dips.”

--Zhang Shidong and Zhang Dingmin. With assistance from Allen Wan in Shanghai, Victoria Ruan in Beijing and Fox Hu in Hong Kong. Editors: Darren Boey, Sheridan Prasso

To contact Bloomberg News staff for this story: Zhang Shidong in Shanghai at szhang5@bloomberg.net; Zhang Dingmin in Beijing at dzhang14@bloomberg.net.

To contact the editor responsible for this story: Darren Boey at dboey@bloomberg.net

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