In Land of 3,500% Stock Gains, Crashes Are Quickly Forgotten

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  • Despite 2015 rout, China shares have surged over the long run
  • Shanghai Stock Exchange celebrates 25th anniversary on Nov. 26

Fang Zhengdao set up shop on a rainy day in mid-November, a yellow umbrella in his hand and a handwritten sign by his side. Two months had passed since the great Chinese stock-market crash of 2015, and Fang figured it was time to start peddling equities again.

That no one seemed interested in money-management advice from a 67-year-old man on a dingy street corner in Beijing didn’t faze him. He’d be back again.

"I’m doing this, helping others to invest in the stock market, because I want to make some money for them and myself,” said Fang, a retired government engineer who’s been trading local shares since 1994. “It’ll take no time for the Shanghai index to climb.’’

As China’s $5 trillion equity rout gives way to a nascent recovery, Fang is a symbol of enduring optimism among the nation’s 97 million individual investors. Not only are old-timers sticking with the market, novice traders have also piled in every week since the crash. What’s more, some of the world’s biggest banks and money managers -- including Goldman Sachs Group Inc. and Franklin Templeton Investments -- say they’re long-term bulls.

While an optimistic stance may be hard to fathom for observers of the gut-wrenching volatility in yuan-denominated A shares this year, the market has been a surprisingly rewarding bet over the long run. Twenty-five years to the day after the founding of the Shanghai Stock Exchange, the bourse’s benchmark index has delivered a 3,548 percent gain, excluding dividends. That compares with 348 percent for the MSCI Emerging Markets Index and 533 percent for the Standard & Poor’s 500 Index over the same period.

“If you look at the compound return for the A share market since it began in the 1990s, it’s actually not bad,’’ said Kinger Lau, a China equity strategist at Goldman Sachs in Hong Kong whose latest 12-month forecast implies a 6 percent gain for the nation’s large-cap CSI 300 Index. “Maybe I’m biased, but I’m more forgiving.’’

Of course, those returns have been fueled by one of history’s greatest-ever economic booms, a feat that’s unlikely to repeat as China’s population ages. For stocks to keep climbing as growth slows, the ruling Communist Party will have to follow through on pledges to improve the efficiency of state-owned enterprises and transform the primary driver of economic expansion from investment to consumption.

Valuation Concern

Mark Mobius, who’s been investing in emerging markets for more than four decades, says he’s confident policy makers will deliver. In September, the government announced long-awaited guidelines to make state-run firms more productive, stressing the need to reform "zombie" companies and accelerate efforts to boost the role of private shareholders. While short on specifics, authorities pledged to release details by year-end.

The economic transition, meanwhile, is already under way. Consumption accounted for more than 58 percent of China’s expansion in the first nine months of the year, versus 43 percent for investment. Retail spending climbed a faster-than-estimated 11 percent in October, while Alibaba Group Holding Ltd. logged a record 91.2 billion yuan ($14.3 billion) in sales during its Singles’ Day e-commerce promotion on Nov. 11.

“Admittedly, it’s not going to be easy,” Mobius, chairman of Templeton’s emerging markets group, said in an interview in Bangkok. “But they are definitely moving in the right direction and that’s why it’s so exciting, because you see this transformation taking place.”

Skeptics worry that share prices already reflect a successful transition. The ChiNext index, China’s gauge of smaller consumer and technology companies, has a price-to-earnings ratio of 81, four times more expensive than America’s small-cap Russell 2000 Index, according to data compiled by Bloomberg.

Boom Bust

Sharp rallies in Chinese stocks -- like the one that propelled the Shanghai Composite Index to a 60 percent gain in the first half -- have often been followed by extended periods of disappointing returns. The last downturn stretched for five years, with the benchmark index sinking more than 40 percent through the middle of 2014. China has had 55 bull and bear markets since 1990, more than six times as many as the S&P 500.

The frequency of boom-bust cycles partly reflects policy makers’ failure to lure foreign and institutional investors to a market where individuals still account for more than 80 percent of trades, said Fraser Howie, the co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.” 

International money managers cut holdings of mainland equities through the Shanghai-Hong Kong exchange link after policy makers responded to this year’s crash by restricting bearish bets, allowing hundreds of companies to halt trading and banning large stakeholders from selling their shares.

“The scary thing is, back then and now, you have the Shanghai Stock Exchange dominated by small speculative investors,” said Howie, who first visited the bourse in 1992 when it was housed in an old hotel along the city’s historic Bund waterfront. “Few would have believed foreigners would have such a limited role 25 years later.”

This year’s intervention is part of a “three steps forward, one step back” process of reform that foreign investors will have to learn to live with, according to Kai Kong Chay, a senior portfolio manager at Manulife Asset Management in Hong Kong. The important thing, he says, is that policy makers seem to be learning from mistakes and pushing forward.

Reform Path

They’ve already started winding back some of the interventionist measures introduced during the crash, including a ban on initial public offerings and curbs on brokerages’ short positions. Authorities are planning to adopt a U.S.-style system for IPOs as soon as next year, and they’ve already started testing an expansion of the Hong Kong trading link to China’s second-largest bourse in Shenzhen.

Locals have taken the volatility in stride, with the total number of registered individual investors climbing for 28 straight weeks to a record on Nov. 20. In another sign of optimism, traders are ramping up use of borrowed money to increase their buying power. Outstanding margin debt on local bourses, which shrank by half during the crash, has rebounded for seven straight weeks as the Shanghai Composite rallied 25 percent from this year’s low in August. It slipped 0.3 percent on Thursday.

For Fang, who’s been forced to liquidate his own holdings more than once during bear markets over the past two decades, the great thing about Chinese stocks is that they always seem to bounce back.

“I’ve seen it all, all the ups and downs,” he said. "I still have faith.”

— With assistance by Tian Chen, and Allen Wan

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