Recent Intervention Helping the Shanghai Composite

The Shanghai Composite has swung from 3,000 to 6,000, and back to 3,000 in a little over a year. To help curb the sell-off, the exchange instituted new rules to restrict large share sales by controlling investors, putting them in a 30-day lockup window, further reducing the amount of new shares and dilution hitting the market.

China is now going further by reducing the stamp duty, or stamp tax, charged on share sales. The tax is being lowered from 0.3% to 0.1% in an effort to reduce buying cost, and increase interest in share purchases. Just last May China and the index did just the exact opposite, raising the tax from 0.1% to 0.3% in an effort to cool a market that was beginning to look overheated.

Not surprisingly, the market liked the recent move and tax reversal as the Shanghai Composite posted a 9.3% increase during the session after the news, and is now trading above 3,500. In addition to the overall increase, over 200 shares hit the daily 10% limit imposed by the index.

Does the reduction in stamp tax increase trading? Yes, but somewhat indirectly. By paying lower fees, investors have more funds to purchase additional or new securities. One estimate has investors saving 120 billion Yuan over the next year alone, with an expectation that some of these savings will make their way into the market.

Of course, with higher return usually comes with higher risk, especially when the move is driven by intervention. As the Shanghai Composite index has just illustrated, both risk and opportunity can come from the same source, but in unexpected ways, and at unexpected times, irrespective of our view of the fundamentals.

As a side note, many of us jump into an international index without really knowing what we are investing in. For instance, consider the S&P 500 Index and Nasdaq Composite. Proxies for their markets? Sure. But it is important to know what these markets represent.

For the China market, shares of PetroChina (PTR) represent about 20% of the Shanghai Composite index value. After reducing the stamp tax, and with a little help from oil prices, shares of PetroChina increased 7.1%, contributing a good deal to the move of the index. Being levered more to oil may not be a bad thing, but it is important to make sure we know what is inside the package we are buying, and whether this makes us more or less exposed to a specific sector or industry. Of course, hoping that any expected or unexpected market intervention will be best for our position is something we have a little less control over, even if we “understand” the market.

Comments

[city]

David, seriously What would you call what Fed Ben did last 4 months ? Free market adjustment instead of panic intervention?

Come on guys; Why everything Chinese government did is always considered second rated?

What a pity you guys do not have the guts and insight to see this on going Credit crisis is the the direct result of your governemnt's policies during the last 15 years!!!

[David Enke]

city, I could not agree more about the Fed. I was commenting specifically on the Shanghai Composite in particular (given their increase in the tax to curb speculation, and lowering of the tax back to the original level now that speculation is less). I try to use the Shanghai Composite as an example, and then speak in more general terms, but you are right, intervention comes in many forms. The recent Bear Stearns intervention is a good example. Sometimes these things hit, and there is very little we can do, good and bad. Furthermore, I wanted to make the point that increases / decreases we see in any index (I used Nasdaq and S&P 500 as additional examples), are also not always what they seem. I doubt that many investors know the impact of PetroChina on the Shanghai, or Microsoft on the Nasdaq or QQQQ. I think these things are worth thinging about. Thanks for reading.

[David Enke]

city, BTW, while it may not have been clear in the article, I don't necessarily consider what they did with the tax, in either direction, a bad thing. Nonetheless, regardless of the view, inntervention moves do usually affect the markets, and are worth considering.

[EdEd]

Most government interven (good/bad, sometime even pepole expect them to). Some even force the government fund (pension plan..) to interven so the governing party might have a better chance to win an election. So guessing what the government will do (Fed/ other) look like is part of the game.

[semuren]

Good article and a good point: look under the hood and know what you are buying. This goes for ETF and other funds too, not just non-US indexes.

One point on the PRC market, in the A shares the is no way to go short. I think being able to short would have made the whole bear market here very different.

[city]

Thank you David for your reply. I am a big Fan of Soros; so I firmly believe Free Mraket without government intervention(or you call it regulation) will lead to total collapse. Having said that; I also think government measures should be more flexible and come as many forms.

One interesting indication in China now is that PBOC has stopped hiking rates instead raised the Bank reserve and exchange rate against USD; this shows people at the top are becoming more pragmatic and open minded.