China’s retail investors are no suckers

The securities industry just rained on China’s bull-market parade.
Stocks took their biggest tumble of the year last week as traders took a rare sell rating from the nation’s largest brokerage as a sign that the government thinks the rally has gone too far. Citic Securities Co. advised clients that People’s Insurance Co. (Group) of China Ltd., a $65 billion giant, could decline more than 50 percent over the next year. Shortly after Citic’s note, Huatai Securities Co. cut its rating on CSC Financial Co., a fellow brokerage. Both stocks had more than doubled in value this year.
Separately, the state-owned China Securities Journal said in a front-page editorial that sell ratings must become “normal” in the future. Putting all these signals together, it’s no surprise that traders rushed for the door.
The downgrades dominated Chinese financial media. But remarkably, no outlet has given any in-depth analysis of why these two state-owned businesses are such stellar performers. If you sift through Citic Securities’ sell report, it’s all praise for PICC’s business operations – except for a brief paragraph stating that the company’s price-to-book valuation is too high.
What’s unspoken is the most interesting part.
There are good reasons for insurers and brokers to be rallying. Insurance companies have huge stock portfolios, so gains in the wider market are prompting investors to re-evaluate their worth. Brokerages, meanwhile, are beneficiaries of trading volume that’s been exceeding 1 trillion yuan a day. In February, the combined net income of 34 brokers jumped 53 percent from a month earlier, according to the Securities Times.
Even in this environment, PICC and CSC Financial have stood out, though. Before the last week’s slump, PICC’s Shanghai-traded shares were up more than 120 percent this year, while those of CSC Financial jumped by more than 230 percent. By contrast, their Hong Kong-traded H shares haven’t joined in the frenzy. To understand why mainland investors have favoured these two companies rather than industry leaders such as China Life Insurance Co. or Citic Securities, look at China’s distorted IPO system.
PICC and CSC Financial are new arrivals to the A-share market, selling stock in November and June last year respectively. As a result, both will have tiny amounts of stock available for public trading (the so-called float) in the foreseeable future. PICC is majority owned by the Ministry of Finance, which guaranteed that it wouldn’t sell any shares for three years at the time of the listing. The national Social Security Fund, which holds 10 percent, agreed to a one-year lockup. Public investors own only 2.3 percent of the insurer’s total shares.
It’s simple supply-and-demand economics that a smaller amount of available stock will lead to an exaggerated move in price – both on the way up and, potentially, on the way down.
More than 350 companies have filed planned share-sale disclosures with the Shanghai and Shenzhen stock exchanges this year. Business insiders, such as founders and parent holding companies, still own most of China’s $6.4 trillion stock market. Once mass-selling starts by these shareholders, the rally is over. Individual investors are buying PICC rather than, say, state-controlled rivals.
Market commentators love to disparage China’s retail investors, calling them “chives waiting to be harvested.” On the contrary, the people’s eyes are wide open.
—Bloomberg

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News