Tighten regulation of the A-share market

While I was covering the stock market in Hong Kong, I often heard investment gurus reiterating an age-old adage: when you start hearing taxi drivers, waitresses, housewives and vegetable vendors boasting about the easy money they are making in punting shares, get out.

I sometimes wonder if the reverse is true too. If it is, then this must be the right time to buy mainland stocks, whether “A-shares” on the Shanghai stock exchange or their equivalents in Hong Kong known as “H-shares”.

Indeed, the prolonged doldrums have driven many retail investors, taxi drivers, retirees and others out of the mainland stock market in despair. Some 650,000 investors, or punters, have reportedly thrown in the towel and closed their accounts with various stock brokerages in the past three months. Others simply followed their herd instinct, causing a stampede that was reportedly described by an official of the regulatory agency as “panic” selling.

In the past few months, the lead indicator has cut through several strata of so-called “rock bottom” to the embarrassment of many stock analysts and commentators. Now, these punters and soothsayers have retreated to the 2,100 level, which they considered to be the absolute baseline, or “diamond bottom,” harder than rock and supposedly impenetrable.

The widely-followed Shanghai Composite Index stood at around 2,136 on Monday. Although it had gained some ground from last week, the index was down a total of more than 10 percent from early June, compared with a rise of 5.5 percent for Hong Kong’s Hang Seng Index in the same period.

Many stock analysts have repeatedly sent out buy signals, claiming that Chinese stocks were a great bargain at current price levels. To support their view, they cited a host of bullish factors, including steady economic growth, government loosening of monetary policy and clear signs of a property sector revival.

But nobody seems to be listening. Whatever increase there is in credit has obviously flown elsewhere, while the stock market is left to wither.

Combined turnover on the Shanghai and Shenzhen stock exchanges shrank to 1.22 trillion yuan in July, down 5.5 percent from June. Analysts expect that average daily market turnover for 2012 will slip to below 130 billion yuan, down from 160 billion yuan in 2011 and 200 billion yuan in 2010.

There have been numerous reports in the past few months, saying that some foreign investment funds were rapidly building up their holdings of Chinese stocks. But their alleged activities have made no obvious impact on the price and turnover of either the A-shares or H-shares. Although the domestic media is always keen to talk up the Chinese stock market, it has made little mention of any significant purchase by domestic institutional funds.

The departure of so many retail investors may have helped to remove a layer of speculative uncertainties that were widely blamed for the irrational and excessive price swings of the past. But the core issue of market transparency that fuelled such speculative uncertainties has remained, as an inhibitor to many institutional investors.

To be sure, the disclosure and other requirements under the mainland securities laws are as tough and demanding as in many other markets. The problem, according to economists and analysts, lies in the public’s low confidence in the authorities’ enforcement efforts, which are widely perceived to have led to many abuses.

In the past several months, the watchdog agency has introduced some new rules to ensure more orderly trading and better disclosure. What’s more, the agency declared openly that it would increase its efforts to clamp down on insider trading practices that were perceived by many investors to be rampant and infectious.

But the agency and the stock exchange need to demonstrate their commitment to enforcement, before they can earn the confidence of the investing public again. To do that, the agency will need to recruit financial experts from outside the mainland’s rather incestuous securities industry. Trusting the enforcement to officials transferred from banks and securities firms just won’t do.