China's A-shares rescue tactics cast shadow

China's seeming success in stopping a precipitous A-shares sell-off raises the question of whether a visible official hand could become a hallmark of a proverbial equity market with Chinese characteristics.

Most market veterans think not. They contend China's leadership will continue to push the country's enormous economy in a more market-oriented direction.

And some say the impetus to do so will come, in part, from the opportunity costs of its recent intervention.

The government went “all-in” as the A-shares market dropped more than 30% in the space of four weeks — giving back roughly a fifth of its 150% surge over the prior eight months, noted Robert F. Baur, Des Moines, Iowa-based chief global economist with Principal Global Investors, in a July 15 report.

Steps taken to short-circuit selling pressure included suspending IPOs, banning large shareholders from selling, directing state-owned entities to buy stock, threatening to punish “rumor-mongers” and easing margin requirements, even though heavy margin borrowing by retail investors had helped turbocharge the market's rally starting in late 2014, wrote Mr. Baur.

As of July 24, the Shanghai Stock Exchange composite index has stabilized, closing at 4,070.91, up 16% from its closing low on July 8 but still 21% below its June 12 peak of 5,166.35.”

In his report, Mr. Baur predicted the direct intervention of the past month would stand in the way of some of the government's high-level goals, which include an expeditious inclusion of A shares in major benchmark indexes — “likely ... delayed” — and the ability to use rising stock prices to help restructure debt-laden state-owned enterprises — “not gonna happen,” he wrote.

“The actions of the Chinese government to prop up the market and influence market players will weigh heavily on the ability of (the A-shares market) to attain respectability internationally,” agreed Mark Mobius, Singapore-based chairman of Templeton Emerging Markets Group.

“Certainly the index creators will be very cautious as regards to putting a heavy weighting on Chinese A shares ... we can't expect very much in the short term,” said Mr. Mobius in an e-mail.

Hopes had been higher at the start of June.

When MSCI Inc. announced its annual review of MSCI benchmark indexes on June 9, the company declined for a second year in a row to begin including A shares in its emerging markets indexes but noted a decision to do so could come before its next review of June 2016, said Nathan Lin, general manager of Hong Kong-based GF International Investment Management Ltd.

Chia Chin Ping, MSCI's Hong Kong-based head of research for Asia-Pacific, declined to comment beyond saying MSCI continues to listen to market players and work with Chinese regulators to iron out remaining issues.

Mr. Mobius insisted it isn't clear the intervention was a success because the market could have recovered on its own. “The government may intervene in the future,” but that would impede the market's ability to win the respect of foreign investors, he said.

“Maturity of a market depends on the government's ability to allow market forces to work in determining prices but at the same time to institute regulations which ensure full transparency, fair dealing and long-term limits on leverage,” he said.

GF International's Mr. Lin demurred, saying the government's role in stabilizing the market over the past month is in the same tradition as moves by the U.S. authorities over the past two decades when markets became unhinged.

While conceding that lax oversight of margin borrowing contributed to the market rising too far, too fast, Mr. Lin predicted regulators would learn lessons from the recent sell-off, tightening control over outstanding margin balances.

Still, both Mr. Mobius and Mr. Lin agreed the mid- to long-term outlook for reform in China remained strong, and that A shares inevitably will become an important chunk of overseas investors' portfolios.

Mr. Mobius said he is convinced China's leadership remains dedicated to fostering a market-oriented economy.

China's leaders will continue to liberalize the economy and open up capital markets, agreed Mr. Lin, pointing to the mid-July move to give central banks, sovereign wealth funds and official institutions quota-free access to the country's interbank bond market as the most recent example.

“I don't agree that (overseas) investors will shy away from the A-shares market over the next couple of years,” said Mr. Lin. China's economy already is large and vibrant enough to offer “lot of opportunities.” For long-term investors, it's not a question of “whether or not,” it's a question of “how and when,” he said.

If the day when the broad run of overseas investors make strategic allocations to A shares remains in question, market veterans insist the latest turmoil offers opportunities for the opportunistic — whether they're looking at long-only investments or alternatives.

The combination of the market's recent roller-coaster ride, combined with the government's intervention, inevitably has created wide gaps between “underlying fundamentals and valuations across markets” that patient investors can take advantage of during this “sorting out” period, noted Robert McConnaughey, Boston-based global head of research with Columbia Threadneedle Investments, in a July 20 report.

Meanwhile, Kyle Shaw, a Hong Kong-based managing director with private equity firm Shaw Kwei & Partners, said the halt in initial public offerings and the likely restriction of secondary offerings of shares as well could prove “very positive for a private equity industry domiciled outside of China.”

With any mainland firm anticipating an IPO now probably having to push back those plans by “at least a year, if not longer,” the environment has become more attractive “for people like us,” he said on a panel discussion in Singapore July 20 at a conference sponsored by the Asian Venture Capital Journal.