China’s Make-Believe Stock Market

I continue to be shocked by ever new article that I read on China. I found a new tidbit of information in the following Bloomberg Business article by Paul Smith: "China's Stock Market Selloff Explained in Six Charts." In reading the article, I discovered that "A-shares listed on the mainland were 49% more expensive than their Hong Kong equivalents on Thursday - the widest premium since March 20, 2009."

What that means is that the exact same shares are listed on the exchanges in mainland China and in Hong Kong. And the shares on the exchange in mainland China sell for approximately 50 percent more than the same shares traded in Hong Kong. According to the chart published in the article, the shares were at parity in November 2015, less than one year ago.

How is this possible? Price discrepancies of less than $0.05 per share would be arbitraged away immediately on US exchanges, but those are real markets. China is now operating a make-believe stock market,

1) that is not open to outside investors,

2) where short-sellers are investigated by "regulators,"

3) that allows 50% of all companies to halt trading in their shares because the price might decline,

4) that prohibits large investors and corporate executives from selling their shares for six months,

5) that invests directly in equities to artificially prop up prices,

6) that suspends IPOs to funnel purchases into existing shares, and on and on and on.

The markets were apparently relieved when the Shanghai Composite index rebounded slightly last week. Really? When investors and traders are not allowed to sell and prices are not allowed to decline, the markets are reassured when manipulated market prices rise temporarily? That's crazy.

I certainly don't have a crystal ball and cannot predict what will happen to China's illusory stock market going forward, but I am not comforted by a small rebound in stocks that trade at a 50% premium to prices determined by a real stock market.

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About Brian Johnson

I have been an investment professional for over 30 years. I worked as a fixed income portfolio manager, personally managing over $13 billion in assets for institutional clients. I was also the President of a financial consulting and software development firm, developing artificial intelligence based forecasting and risk management systems for institutional investment managers. I am now a full-time proprietary trader in options, futures, stocks, and ETFs using both algorithmic and discretionary trading strategies. In addition to my professional investment experience, I designed and taught courses in financial derivatives for both MBA and undergraduate business programs on a part-time basis for a number of years.
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