Guest Post: Was The Chinese Government Behind The Stock Rally?

Submitted by Yong Liu

Was The Chinese Government Behind the Stock Rally?

Measured by the Shanghai Stock Exchange Index, the Chinese stock market advanced 12% in 10 trading days in October 2010. While investors big and small are celebrating their returns in a market where shorting stock is not allowed, a bigger topic emerges: how did it happen? Increasingly, people point their fingers to the direction of Beijing.

Green Shoes

People still remember the previous bull market. It started on July 19. But the seed of the bullishness was planted the previous Thursday when China Agriculture Bank struggled with its IPO. For two days, the Shanghai index stuck at 2424 level. Mysteriously, the index advanced 2.1% the next Monday. By the end of the week, the index was at 2572 level.

During this time, Chinese media reported that American asset managers including Capital Research & Management and Morgan Stanley made hundreds of million profit through Agriculture Band H Shares in HongKong. In Shanghai, big insurance, central government asset managers and hedge funds also leaked information that they were actively buying the bank stock.

Zhang Yunzheng, president of Agriculture bank came out to disclose a green shoes mechanism and attributed the success of the IPO to this mechanism. However, Zhang was not clear about the nature and details of the mechanism. People were left wondering with a number of questions: Is this mechanism a government project to manipulate the market? Or is this a public private joint venture to achieve this purpose? If so, how a private investor can participate? Who are allowed and not allowed to participate? Is the green shoes short term in nature or permanent?

Like stock markets everywhere else in the world, the market voted with great excitement before any question was answered. A bull market was formed. The week ended up 6.1% for the week . For retail investors, the signal was a break out of 60 day moving average. Remember the 60 day moving average, it was a consistent message for the cycle.

By early August, the market reached a 2 month high and repeatedly tested 2670 level with large volume. Volatility was high during mid August. Winks and nods were abound in the market that green shoes was finished. Bulls were not convinced, the market was headed to 2700 level.

No official came out to declare the end of the green shoes. By mid September, only fools rush in because the market fell through the 60 day moving average. On September 16, Agriculture bank was traded below the IPO price with heavy volume.

Non Circulating Shares

With Agriculture bank story forgotten almost immediately (just like any other stock market), the market was starting to worry about a number of things. Top among them is an incoming flood of expiration of non circulating shares.

I don't know anyone who is happy about non circulating shares. Nor do I know anyone who knows anyone who is excited about it. For most investors, non circulating shares bring fear and sadness.

Non circulating shares are stocks allocated to an exclusive group of people or institutions. The shares are priced like option except it is a deep in the money option for the price of a deep out of money option. It is called non circulating because holders cannot exercise it before expiration. When expiration day comes, investor shares are diluted like a soup for obvious reason. The first wave of expiration came when the Shanghai index was above 5000 level. The market was still struggle below 2700 at the end of September 2010.

Chinese media report a new wave of expiration. The volume number for September was 105 billion. More to come in ensuing months.

This Time Is Different

If you (like me) think the market would correct in October because of the giant negativity, you ain't learned nothing for your years of studying!
Only it is not just you and me. Chinese stock market started trading on October 8 after a week of national holiday. The trading day was closed at 3.1% rally. Most people were scratching their heads for an answer.

Someone quoted Wind data for a proof: between September 30 and October 18, 223 of 394 mutual funds were decreasing or flat their holdings. They missed a 446 points rally. News media was heavy on QE II. It sounds like a super cruise line with a lot of fun for stock markets
all over the world. Only the articles were filled with things like printing money.

Why news like U.S. print a lot of money is bullish for Chinese stock market is beyond me. After all, the backbone of the market is ma and pa retail investors throughout the country.

But stock market has a common gene. When American investors cannot deal with their negativity, they theorize Uncle Ben (Uncle Ben already had a lot to offer before anyone asked). In China, we also theorize someone. And that has to be Beijing. Again, no details (no one came out to disclose anything).

A lot of questions unanswered. The market always buys first and asks later. Maybe next time the stock market advances, we will ask the same question again: Is The Chinese Government Behind the Stock Rally?


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