My Blog

May 31, 2008

SAT 31 MAY

CSRC to mutual funds: Stop selling! By Michael Pettis

CSRC to mutual funds:  Stop selling!

 

I am not sure what impact this is likely to have in the market, but on Friday and over the weekend there was a lot of discussion about reports surfacing that the CSRC is trying to put pressure on Chinese fund managers to support share prices by restraining their selling activity.  According to Saturday’s South China Morning Post:

 

For the second time in three weeks, the mainland's stock market regulator has told fund managers not to dump shares. And this time, it says they could be punished if they don't comply.

 

The China Securities Regulatory Commission said mutual funds should support falling stocks even though other investors were selling their holdings amid the slump in the nation's equity markets. With concerns rising about the deteriorating economic conditions and with the authorities having so far failed to stem the slide through market-boosting measures, Beijing is now resorting to threats in an effort to maintain so-called market stability.

 

My student Shang Ning tells me that he heard that the funds were lectured about the need to begin acting “politically correctly,” which doesn’t mean what it means in the US and the UK but rather can be interpreted to mean “in the interests of the country.”  I suppose it would be cheap cynicism to discuss what that might really mean in practice.  At any rate, from what I hear, the concern is that whenever the government has changed regulations or otherwise signaled its intention or desire to see higher prices, funds generally were among the earliest participants in the subsequent rally, but they have also been quick to take profits, selling aggressively into excited retail demand.  This has prevented, according to some observers in the government, their signaling effects from having a bigger impact on the market.

 

I disagree.  I wrote many months ago (and this is no great insight of mine – it is fairly well-known) that government intervention is most powerful when least used, and each time the regulators intervene to move prices, they lose credibility.  The government has intervened so often in the last twelve months to push prices up or down, according to the needs of the moment, that it was only a question of time before these interventions stopped having much impact.

 

The market’s reaction to the news on Friday was not terribly positive – it traded up for the day, but only by 0.94%, which in the Chinese stock markets is probably the typical trading range in any given half-hour, and it had little conviction either up or down.  Some analysts are suggesting that this is good news for the market because it indicates how serious the government. Is about propping up prices, and that without heavy mutual fund selling the market is protected from further losses.  Maybe.  But it is just as easy to read this as a fairly desperate attempt to keep prices up, and if I were invested I would almost certainly close out my positions.  If too many people do this, mutual funds could begin to see redemptions, which would force them to sell.

 

.According to the same South China Morning Post article:

 

“It is an open secret that the regulator wants to rig the index above the 3,000-point level," said West China Securities trader Wei Wei. "However, retail investors now refuse to buy it. The worst is yet to come."

 

Everyone seems to think that the government is doing all it can to prevent the market from going below 3000 (it closed at 3391 on Friday).  I have already discussed the market dynamics of a general perception that some large player is trying to maintain a minimum price.  If it breaks below that rpice, it will break big.

 

On a separate note, PBoC governor Zhou Xiaochuan said Friday that the trade surplus was not the cause of China’s huge increase in reserves.  According to another article in the South China Morning Post:

 

“When analysing this issue, you have to make a comprehensive check of the overall international balance of payments,” Mr Zhou said in Beijing yesterday. “If you look only at the trade surplus and FDI, these do not cover everything,” he said, citing trade in services and the increasing sophistication of the country's financial markets.

 

Yes and no.  I think it is pretty clear that trade is no longer the big driver of reserve growth, but I don’t think services and financial market sophistication are the main drivers either.  For many years China was locked into a self-reinforcing system of rising trade surpluses generating monetary growth, which generated further rising trade surpluses, but the risk was always that at some point the subsequent pressure for RMB appreciation would itself start to generate speculative inflows that would eventually become the driving force for reserve growth.  I think we are clearly in this very destabilizing stage.