China's Stock Market, Including Shanghai, Shenzhen, and Hong Kong

Why China's Stock Market Is Like a Casino

The Chinese stock market
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China's stock market is an exchange where shares of Chinese companies are traded. It was founded 100 years ago. It's the second largest in the world after that of the United States. On June 20, 2017, Morgan Stanley Capital International announced it was adding China A-shares to its emerging market index. In June 2018, the company named the 200-plus firms. This increased China's stock market size by $11 billion. The move forced asset managers who track the index to purchase China A-shares for their own portfolios. The emerging market index holds $1.8 trillion in assets.

In 2015 and 2016, huge price swings made China's stock market seem like a casino. One reason for the volatility is that the market is thinly traded. Only 7 percent of China's population own stocks. Since participation is so low, a few wealthy investors own 80 percent of tradable shares. They drive the price swings in China's stock market.

China's leaders encourage investment as part of its economic reform. A healthy stock market will fund innovative smaller companies and boost China's economic growth. It would provide an alternative to bank debt. As an attempt to curb volatility, China's Securities Regulatory Commission established automatic circuit breakers in January 2016. The Commission withdrew the breakers after only four days because they only made things worse.

Unlike the U.S. stock market, China's stock market doesn't indicate the health of China's economy. The total value of every stock traded on its exchanges is less than a third of its economic output, as measured by gross domestic product. That compares to 100 percent for most developed countries.

In China, less than 20 percent of household wealth is in the stock market. Instead, most are fully invested in real estate. Banks only offer low-interest rates on savings accounts, since the central bank keeps rates low to make lending cheap.

China's Stock Exchanges

There are two exchanges on the mainland. The Shanghai and Shenzhen exchanges were opened by the Chinese government in 1990 as a way of modernizing China's economy. The Hong Kong stock exchange is being integrated into the other Chinese exchanges. That makes the HKEx loosely part of China's stock market.

The Shanghai stock exchange is China's largest. Its total market capitalization was $4.1 trillion in 2016. Most of the companies listed are the large, state-owned companies responsible for China's economic growth. Most investors are pension funds and banks. The SSE is located in Shanghai, China's financial capital.

The Shenzhen stock exchange is a smaller exchange. Its market capitalization was $3 trillion in April 2015. The SZ is in Shenzhen, Guangdong, one of China's most modern cities. It’s a two-hour drive from Hong Kong. Most investors are individuals.

The Shenzhen trades the shares of smaller, more entrepreneurial companies.  Their growth is a critical component of China's economic reform. These privately-owned businesses are more innovative and more profitable than the state-owned companies. A lot of tech companies are listed there, making this exchange similar to the NASDAQ.

Compare Shanghai to Shenzhen by Sector

Sector Shanghai Shenzhen
Manufacturing 28% 60%
Financial 32% 7.2%
Mining Less than 3% 15%
Transportation 5.1% Less than 3%
Real Estate Less than 3% 4.9%
Utilities 4.5% Less than 3%
Retail and Wholesale Less than 3% 3.3%

The Hong Kong Exchanges and Clearing Limited or HKEx, is a stock market and derivatives market. The Hang Seng is the index that tracks the Hong Kong stock exchange. It is in Hong Kong, a city-state that was transferred from the United Kingdom to China in 1997. Mainland China selects Hong Kong's administrator, but it has its own currency, judicial system, and legislative branch until 2047.

In November 2014, the Chinese government linked the Shanghai exchange with the Hong Kong exchange through the Shanghai-Hong Kong Connect program, and added the Shenzhen market in late 2016. The Connect program allows foreign investors to buy shares of Chinese companies. Prior to the program, only Chinese citizens and a few foreign fund managers could trade mainland China stocks. Chinese citizens are allowed to trade up to $1.7 billion a day. It also encourages Chinese savers to buy stocks and earn higher returns. 

It is part of President Xi Jinping's economic reform plan to help heavily indebted state-owned companies. Higher share prices allow them to raise cash in the stock market.

Many companies are now listed on both the Shenzhen and Hong Kong exchanges. Stock prices are often cheaper on the Hong Kong exchange than the Shenzhen. That attracts mainland investors.

China Stock Indexes

The Shanghai Stock Exchange Composite Index tracks the Shanghai exchange. SHCOMP does this by tracking the daily price of A-shares and B-shares weighted by the total number of shares issued. Price changes of larger companies affect the index more than those of smaller firms. That means it is a capitalization-weighted index, like the Standard & Poor’s 500. 

The Shenzhen Index tracks the stock prices of all A and B shares on the Shenzhen exchange. SZCOMP is a capitalization-weighted index.

The Hang Seng Index tracks the Hong Kong stock exchange. HSI reports the prices of the largest and most frequently traded companies listed on the Hong Kong exchange. No company can represent more than 10 percent of the index value. Like the Shanghai index, it weighs the share prices by the number of shares. It also weighs the values by a free-float factor. There are four sub-indices: Commerce and Industry, Finance, Utilities, and Properties. 

History

China's first stock exchange opened in the 1860s in Shanghai. It closed for 41 years during the Cultural revolution. In 1990, the Shanghai Stock Exchange opened again. Private investors bought shares of state-owned businesses.

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