'The market has fallen to record lows and share prices are close to net asset values' Shanghai fund manager NO, NOT QUITE a record low, unless you assume there was really no stock market in Shanghai at all before 1998. I am even more dubious of the claim that share prices are close to net asset values. Here is the big puzzle for you. Over the past four years, the mainland's gross domestic product has grown by 57 per cent (70 per cent for Shanghai) but on the Shanghai stock market, the composite index stands at only 57 per cent of its value of four years ago. And it is not only against the mainland economy that this performance looks so miserable. As the second chart shows, you would have done three times as well with your money since mid-2001 if you had spread it across other Asian stock markets outside of Japan instead of having it invested it in the Shanghai market. This does not compute. China has been the economic powerhouse of Asia in recent years, with nominal GDP growth running at more than 10 per cent a year on average, well above what other Asian countries have been able to show. It has attracted the lion's share of direct foreign investment and has steadily grabbed export market share from all the others. Yes, it can happen that a country's economy booms while its stock market withers, but for short periods only and short in these matters means a good deal less than four years. Something is amiss here and I tend to think that share prices tell the truth a good deal more often than government economic reports. I raise the question of this anomaly today because the authorities in Beijing have once more embarked on plans to sell non-tradable state and legal-person shares valued at two trillion yuan at present day prices. These shares constitute about 65 per cent of the issued capital of mainland listed firms. A common view of this in the mainland is that these shares are the reason for the poor performance of mainland equity markets. They constitute an overhang that can be dropped on the market at any time and investors are staying away until the overhang has dropped. Thus, say the authorities, let the overhang drop and there will no longer be a reluctance to invest. It will have to be done carefully, of course, hence the minatory warnings to insiders and market manipulators not to trammel the process. But surely there must be a way of doing it that does not lead to an immediate big crash - and think of the glory days to come once this problem is out of the way. I am not so sure. Leave alone that two trillion yuan's worth is a mighty big overhang, I am not convinced that the market's ailments can be ascribed to such technical causes alone. If the earnings prospects of these shares were really as good as the stated performance of the underlying economy suggests and if they are now really trading at near net asset value (although book net asset value is by no means a guaranteed floor to a market decline), there would be little problem in finding buyers for the state shares. In fact, the market under such a scenario would be as likely to go up as down on the prospect. The sale would enormously enhance the liquidity of the market and Shanghai would become a must inclusion for international fund managers tracking benchmark indices. The biggest obstruction to a market's performance is rarely lack of money. It is lack of good ideas. Let the companies be solid ones with good returns on investment and the money will follow. I simply don't buy the overhang theory. I think the Shanghai market's problem is the conventional old one that returns on investment are poor and set to get even poorer. I shall grant you that the hard proof is not entirely in yet. You never get it until after the fact with stock markets. But it is my guess that real net asset value in Shanghai, the sort of net asset value that is based on discounting credible forecasts of future free cash flows, is declining just as fast as the share prices are. Possibly faster.