How China's Stock Market Differs from Others

A Look at China's Unique Stock Market Dynamics

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China’s stock market was valued at over $10 trillion in mid-June 2015, according to the World Federation of Exchanges, split between the Shanghai Stock Exchange and the Shenzhen Stock Exchange. While these figures place it right between the NYSE’s $20 trillion and the NASDAQ’s $7 trillion in market capitalization, China’s stock markets have a number of big differences when compared with other developed markets around the world.

In this article, we’ll take a look at some of these key differences and how they play a role in the country’s equity performance.

Individual Speculators

The majority of U.S. equities are owned by large institutional investors that are focused on long-term investing, even though actual trading is dominated by high-frequency traders that attempt to profit from short-term imbalances in the market. Around the world, most developed markets operate in the same manner with international hedge funds, mutual funds, and other institutional investors placing capital across assets in order to maximize diversification and returns.

By contrast, four-fifths of Chinese equities are held by individual investors with 112 million accounts in Shanghai and 142 million accounts in Shenzhen. Many of these investors have utilized margin lending by brokerage firms in order to leverage their accounts and enhance their overall returns, despite margin interest rates as high as 20%.

These dynamics have made the Chinese markets inherently more unstable than their global counterparts across the developed world.

China’s stock market may be largely held by individuals, but equities account for less than 15% of household financial assets and equity issuance accounts for less than 5% of social financing.

Any decline in the country’s stock market would certainly affect individuals, but it’s unlikely that the drop would be catastrophic to the country’s general population. However, increased lending by brokers and other parties could change these dynamics in the future.

Outsider Limitations

China’s stock market has long been off-limits to many foreign investors, but these dynamics started to change in 2014 with some new rules. China gave investors greater access to its market in an effort to lure foreign capital and transform its market from a primarily individual-controlled market to one that includes more long-term institutional investors. The hope is that these subtleties would add a bit of stability to prices over the long-term by avoiding pure speculation.

The Shanghai-Hong Kong Stock Connect program enabled investors to buy shares on the Shanghai Stock Exchange, while permitting wealthy investors in mainland China to purchase stocks trading on the Hong Kong Stock Exchange. While the program only opened the market to certain Chinese companies, the hope is that it will be expanded over the coming years to include a greater number of companies and exchanges.

Institutional investors may demand some additional changes before they invest as well, such as greater transparency and accounting controls.

Over the past several years, Chinese equities have been plagued by a combination of accounting and political scandals that have sent these investors fleeing from any larger investments in the country. The good news is that the government is taking actions to improve in many of these regards.

Looking Ahead

China has been working hard to bring its financial markets up to the same standards as many developed countries around the world. But, government meddling in the markets may keep them outside of many major indexes that traders and investors use to guide their buying and selling.

MSCI Inc. announced in June 2016 that China's attempts to stem its stock market declines could keep it out of global indexes. As one of the largest index providers in the world, MSCI carries a lot of weight in adding countries and equities to its benchmark indexes.

Many mutual funds use these indexes as a basis for their strategies. The addition of China to its emerging market index could spur a large amount of buying as mutual funds and exchange-traded funds (ETFs) build exposure.

For now, it seems that major index providers are waiting to see how further market reforms progress before adding China to emerging market indexes. This means that its markets will likely continue to see individuals account for the majority of equity ownership.

Key Takeaway Points

  • China’s stock market was valued at over $10 trillion in mid-June 2015, split between the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
  • The majority of developed market equities are held by institutional investors focused on the long-term, while China’s equities are held largely by short-term individuals.
  • Chinese equities remain off-limits to many foreign investors, despite a number of reforms aimed at opening the market over time.