25-year veteran explains what counts, and what doesn't...
I'VE BEEN riding the rollercoaster of the Chinese equity market for many, many years now, writes Peter Churchouse, editor of The Churchouse Letter, in Steve Sjuggerud's Daily Wealth.
And more than 25 years after my first hands-on experience with the market, it still has certain unique characteristics that set it apart from other large stock markets around the world...
#1. China is driven largely by internal events
What is happening in the US, Europe, and other parts of Asia often has minimal impact on the Chinese domestic equity market. This is because the market is almost entirely driven by local investors. There is very little foreign involvement in China's equity markets (less than 2% of the equity market is owned by non-Chinese organizations).
#2. Fundamentals don't matter that much
By this, I mean that company earnings, balance sheets, and all the other traditional stock-valuation metrics that drive most large markets are less important in China.
Retail investors account for around 80% of trading in the market. These investors are much less fundamentally driven when it comes to their stock selections. They thrive on rumors, tips, and social media.
#3. China's market is volatile, as it is dominated by speculators
I've followed and been involved in the mainland Chinese equity market for decades now. It's been an extraordinary ride. There have been huge, rapid bull markets, followed by swift corrections – and then years where not much happened in between.
#4. Policy intervention happens frequently in Chinese markets
The core of China's government culture holds a deep and constant propensity to tweak, direct, and otherwise control most aspects of economic life. The authorities can't resist the temptation to meddle. The stock market is no exception.
#5. China's population and its government are big savers
The country as a whole saves around 45% of its GDP. This is more than twice the average savings in most of the Western world.
So what do people in China do with these savings?
In reality, people in China don't have many avenues to invest. There is not a big mutual-fund industry, widespread pension schemes, or other insurance-linked investment vehicles. Capital controls mean that people cannot buy foreign stocks or bonds. And bank deposits pay very low interest rates, almost always below the rate of inflation.
So what's left? There are two main avenues for investment: real estate and the local stock markets.
If the stock market is looking dull, real estate gets the savings Dollars. If the real estate market is looking soft, people head for the stock market.
#6. China's markets have a number of different types of shares
While China's domestic market was off limits to outside investors, the authorities encouraged lots of its big, high-profile companies to list on the Hong Kong Stock Exchange via "H" shares. These are shares of a company that is incorporated in China but listed in Hong Kong. Listing in Hong Kong requires approval from China's regulatory authorities.
And then there are the "red chips". These are Chinese companies that are incorporated outside of China, with shares listed in Hong Kong.
Both groups of companies are controlled by mainland China's government entities.
These two groups of companies now make up around 40% of the total market capitalization of the Hong Kong main board market, or about $1.41 trillion. Some 374 companies fall into these two categories.
Hong Kong also lists companies called "P chips". These are Chinese companies that are listed on the Hong Kong exchange and incorporated in the Cayman Islands, Bermuda, or the British Virgin Islands with operations in mainland China.
They are NOT controlled by Chinese government entities.
Adding this category onto the H-shares and red-chip list would take the Chinese-company component of the Hong Kong market to more than 50%. That is without including the China component of Hong Kong's own listed companies.
This all means that the Hong Kong market has increasingly become a proxy for Chinese exposure.
However, exposure to Chinese companies and markets via Hong Kong represents only a small part of the second-largest market in the world...a market where growth is almost endemic.
Given its size and growing role in equity markets as China's markets become more open, global investors simply cannot ignore mainland Chinese stocks anymore.
This is a market I think you should be exposed to.