Mainland markets march to their own financial drummer
This week's sell-off in global equities started in the mainland but as Asian stock prices slid further yesterday, the only big market unaffected by the continued slump was the mainland itself.
That should not be surprising. Events this week have shown swings in the mainland's A-share prices can have a powerful influence on investor sentiment towards markets elsewhere in the world. But the mainland's stock exchanges remain driven by domestic, not international, forces.
Despite enormous strides in recent years at improving standards among local brokers, strengthening institutional investors' role and inducing better-quality firms to list, the mainland's onshore markets remain predominantly speculative.
Price movements are driven by millions of small investors in search of fast returns. They dip into the market on rumours and are quick to take profits should the whispers turn bearish. But if the market falls significantly, they are just as eager to seize the opportunity to jump back in again.
This is pretty much what happened yesterday. Following Tuesday's 9.24 per cent slide in the Shanghai and Shenzhen 300 A-share Index, money swept back into the market and the index bounced back by 3.54 per cent.
Despite Premier Wen Jiabao's pledge yesterday to safeguard the stability of the country's financial markets, such volatile swings are likely to remain a factor of life for mainland investors for the foreseeable future.
That is because despite the market's volatility, punting on shares promises far better returns than the limited number of other investments available to investors.
At the moment, mainland households have 16 trillion yuan on deposit with banks. But with three-month deposit rates below the rate of consumer price inflation, many are watching the value of their savings erode. Not surprisingly, speculating on a stock market that has tripled in value in just over 18 months appears an attractive option.
With the authorities reluctant to raise interest rates significantly, the trend is likely to continue. Stock prices will shoot up as new money enters the market. Then, they will plummet again in response to fresh rumours.
Such falls may trigger broader sell-offs in global markets but they are not the underlying cause. Global markets are jittery because international investors have taken record levels of risk. Tens of billions of US dollars have been borrowed through the yen carry trade and used to buy high-yielding assets around the world. As a result, market volatility has been compressed to record lows.
In such an over-extended environment, it does not take much to start a wholesale retrenchment. We have had a warning just how severe that could be in the past few days. It is no accident that as stock markets have dropped, the yen has gained dramatically against the US dollar and the VIX index of US equity market volatility has shot higher.
The current global sell-off may or may not continue. If it does, the one big market unaffected will be the mainland. The mainland can shake the world but mainland markets march only to a domestic drummer.