China’s Stock Market Has Changed

Caifu Magazine | by David Ren, Chairman of CAIFU Magazine

China's stock market is now quite different. The valuations of the blue chips across the board are on the rise, while the valuations of the underperforming small caps are going down. What has changed is not just the outlook of the stock market or the so-called structure of the market, but the concept of investment philosophy. The future market may not fall too much, but many individual stocks will continue to fall. And in the future, the market index may not surge to a record high, but some stocks will be skyrocketing.

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One of the major reasons behind this trend is its changing system. With more and more new stocks listed, the Chinese stock market is closer to the registration system. Under registration regulation, shell resources will become increasingly meaningless. The world is destined to have a small number of companies grow bigger, while most stay in disadvantaged positions, or even die off, which is normal. In the past, China's stock market speculated on junk stocks a lot, while some well-performing large caps received no attention, some poor-performing small caps were heavily traded, which has been abnormal all along. We saw a reverse of that recently, with the valuation of blue chips in the broader market rising and the underperforming small caps falling. For some time in the future, we will see some good stocks make more gains, while most stocks drop.

Funds still push the outcome, since the stock market is built on capitals piling up. Stocks will rise whenever they are favored by funds. Today, funds in the market are quite different from those before. In the past, it used to be a bunch of minor market makers trading aimlessly. Now it is those powerful big players making rational decisions. They have strong research abilities, so the rise of blue chips is not entirely because of big players supporting each other, but the result of the convergence of investment concepts. In the past, when the market makers trading junk stocks for lucrative speculations, often it involved serious irregularities. Now under strict management and severe punishment, those living on the type of speculations find it more difficult to survive.

In the trend of the broader market, the past used to be spectacular when good times came, and sluggish like a long night after the good times have passed, with everyone trapped or lost. In the future, it will probably be the other way around – rallying with hesitation, but dropping in a tumbling storm, then soar to a new high again once people all left the market in a panic. In the past, it used to be the market makers controlling the board, but in the future it will be institutions trading simultaneously. With their different financial structure, this could lead to different outcomes.

In the future, you have to study the industry and its individual stocks, and find reasonable valuation to make money. For example, in the industry sector, China has two shining aspects in recent days. One is its domestic electronic brands, led by mobile phone producers. This sector is growing stronger, promoting in turn the domestic-made electronic components as an alternative, while some companies will become bigger. Another one is China’s national car brands which are beginning to cut a striking figure. In the future, the market shares will be flowing toward dominating enterprises. In turn, their supporting enterprises will grow stronger, among which there are many undervalued high-growth companies. After the “Beautiful 50,” it would be just natural to look for a second echelon, a “Beautiful 100.”

Since China’s stock-market bubble in 2007, it has absorbed the valuation pressure of full circulation of uncirculated stocks. In the future there will be yet another long period for China’s stock market to absorb the pressure of valuation of its registration system. Perpetual change is the eternal truth in the stock market. A different market will provide different opportunities, and will call for different ways of thinking.