Futures Shock Slams Chinese Equities
Chinese Stocks Let Off Steam Through
A New And Very Significant Opening
Chinese equities took a hit in Friday’s trading, as a perfect storm unnerved global stock markets. Already facing some fears of credit tightening by Beijing and a possible rise in the value of the yuan, Chinese stocks let off steam through a new and very significant opening, the newly created Stock-Index Futures market.
Stocks in Shanghai dropped Friday by the most in a month after the launch of so-called “Stock-Index Futures.” The benchmark Shanghai Composite Index fell 1.1 percent, or 34.7 points to close the week at 3,130.3 points.
Declines in Shanghai were amplified in New York as the Goldman Sachs debacle increased investor nervousness. The China ADR Index gave up almost three percent, in an exaggerated reaction to events on both sides of the Pacific. Because this loss is not based on fundamentals, the Index seems likely to recover its momentum after opening-day jitters over Stock-Index Futures subside, and western markets digest the Goldman news.
The opening of the Stock-Index Futures trade in China is actually a very small event in terms of the gross amounts of cash in play. Fewer than 10,000 investors have opened Stock-Index Futures trading accounts, and the size of most accounts is believed to be small because investors are required to have a minimum of $73,000 in investable assets in order to qualify. Most institutions are still believed to be on the sidelines.
Nevertheless, the debut of Stock-Index Futures briefly destabilized the already volatile world of stock trading in Shanghai and Shenzhen. At the China Stock Digest, we believe the destabilizing effect will be temporary, and the long term effect will be beneficial. Why? Because, for the first time, investors will be able to make money by betting on a decline in Chinese markets.
China’s Stock-Index Futures are based on four contracts tracking the CSI 300 Index, which follows the 300 biggest stocks on the Shanghai and Shenzhen stock markets.
Until the introduction of short-selling and futures contracts in China, the only way for investors to make money on the stock market was to bid prices up and sell out before bubbles inevitably burst. With more than 70 percent of stock trading in China in non-institutional hands, private investors churned up a good deal of volatility, making for a boom and bust atmosphere in Chinese A-share markets in recent years. Tellingly, excessive valuation on the mainland was not reflected on the more mature Hong Kong and New York stock exchanges.
According to Bloomberg, the Shanghai Composite trades at a historical price-to- earnings ratio of 35.7 times, compared with the current 27.6 multiple. The Hang Seng China Enterprises Index, made up of mainland companies trading in Hong Kong, is valued at 17.5 times earnings.
The arrival of derivatives in Shanghai and Shenzhen should help tame asset bubbles over time. Excessive P/E multiples which plagued stocks on the mainland for years should be moderated by tools like Stock-Index Futures which will tend to level out speculative frenzies and reduce downside volatility.
We’re looking at Friday’s gyrations as short term pain with a long time gain. “Derivatives” may have become a dirty word in the banking debacle. But derivatives that reduce volatility and discourage speculation are signs of growing maturity in China’s fledgling stock markets.
