Assessing China’s Stock Market

The volatility of the Chinese stock market has been viewed by U.S. investors with a mixture of concern and fascination. As of August 4, the Shanghai market is still up 16% year to date even after a nearly 30% decline from its June 12 peak. This roller coaster ride has received a great deal of attention; however, the impact on China’s economy is expected to be limited.

Until recently, the Chinese stock market was walled off from the global financial market. Chinese investors could only invest in “A-shares” traded in Shanghai or Shenzhen, and non-mainland investors were not allowed to buy shares in these markets. Though there are now options for non-mainland investors, these investors represent less than 2% of the Chinese stock market.  

The link between China’s economy and its stock market is not as strong as it is for the U.S. Chinese investors prefer to hold cash and real estate relative to stocks; only 9% of Chinese household wealth is invested in the stock market, compared with nearly 30% in the U.S. Most of the money in the Chinese stock market comes from a relatively small group of wealthy (by Chinese standards) investors. Looking historically, regardless of the performance of the equity market, there appears to be very limited correlation between consumer spending and stock prices.

We believe the recent decline in the Chinese stock prices is likely a reaction to a 60% rise in less than six months and the rapidly changing government policies. In April, the Chinese government limited margin lending before quickly reversing course as equities sold off sharply. It has worked to prop up stocks in July and August. These moves, including banning short selling and restricting trading, have been viewed as evidence of panic by policymakers.

While the slowing Chinese economy may be having some impact on the equity market, China’s overall economic outlook is largely unchanged. The small role the market plays in the economy is unlikely to have a material impact on economic growth.

LPL Research continues to recommend that investors who desire exposure to the Chinese market achieve it by investing in the so-called “H-share” market, shares of Chinese companies that trade in Hong Kong. The Hong Kong market has a more traditional regulatory structure and less intervention than the mainland Chinese market. This market has been less susceptible to wild swings and is more attractively valued than the “A-share” market based on price-to-earnings multiples. This fact does not eliminate the volatility inherent in any China-related investment, but it does offer investors a better risk-reward balance.