The Red Dragon Casino

By Ricardo Rivera  July 6, 2015

rrivera@ufm.edu

 

In the West we have the notion that gambling and the concept of fortune are ingrained in Chinese culture. This is probably because gambling carries implicit notions of individualism, such as property and risk. Individualism that is a quality of the human condition but has never before been experienced by this Asian country with the same vitality as is common in the West.

The recent stock market crash has some people thinking that such a collapse is largely the result of China’s propensity for games of chance. What is certain is that in a stock market where 90% of the market is composed of retail investors and margin financing, it is understandable that a cultural factor would have a large impact on its performance, especially when lending for stock investing has reached more than USD 340 million.

It’s always risky to try to predict what will happen in the stock market, more so when the variables involved do not conform to what we consider a rational model. However we can glimpse into the likely intentions of the Chinese Communist Party, whose actions reveal what we believe to be an attempt to inject liquidity into the private sector through a stock market with relatively low activity. Last week’s twenty-five basis point reduction in the benchmark rate by the People’s Bank of China, the easing of rules and regulations for local government pension funds that made USD 100 billion available for stock purchases,[1] and the lowering of equity trading transaction fees tells us that there is still much more to come.

The latest move by the Communist Party has been to suspend initial public offerings (IPOs), the same measure it applied in early 2012 that lasted more than fourteen months. The last time IPOs were suspended, the government took the opportunity to reform the mechanisms and regulations of public offerings. This new suspension makes it clear that the government is worried about the possible repercussions that high volatility in the stock market may have on the real economy. The purpose of suspending IPOs is to stabilize the market by preventing investors from selling shares to purchase new offerings. In addition, there is also a proposal to create a market stabilization fund. This would be the first time that China would use these types of mechanisms, although they are still pending approval by high-level party officials.

According to the Wall Street Journal, year to date in 2015 there have been 220 IPOs, compared to 125 for all of 2014. Today there are more than sixty million new trading accounts compared to May 2014 (an increase of 26%), while the average amount of funds by account has doubled from 89,240 to 178,620 yuan.[2] At the moment, it seems the only thing exceeding the quantity of new shares is the cash available to purchase them.

Under these conditions, with 90% of the market composed of retail investors that respond more to herd mentality than shareholder returns and with an avalanche of cash available, you’re probably wondering should I invest or not? The question is not whether you should invest, but whether you’re feeling lucky. Are you willing to try your luck in the red dragon casino, even when the house decides how many aces are in the deck?

[1]. Pension funds managed by local governments were previously prohibited from investing in the stock market, but now the rules have been eased allowing up to 30% allocation in the stock market.

[2]. http://si.wsj.net/public/resources/images/AI-CQ708_CSTOCK_16U_20150701134207.jpg