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China stocks' rise interrupted by regulation fears

Wary of bubbles, government tightens its grip on financial markets

An investor looks at stock information at a brokerage in Shanghai on Nov. 24.   © Reuters

HONG KONG -- While the U.S. and Japan rested Thursday, the Shanghai and Shenzhen stock exchanges were busy plummeting over concerns about China's slowing economy and a crackdown on speculation. Yet few predict a protracted slump, anticipating an influx of foreign funds as share prices sink.

The Shanghai Stock Exchange Composite Index fell by 2.3% on Thursday, its largest drop this year, then mounted a weak recovery Friday. The Shenzhen Exchange's ChiNext board for emerging companies shed more than 3% on Thursday and continued to tumble Friday.

White horses

In China, a white horse refers to blue-chip stocks such as beverage company Kweichow Moutai or electronics maker Midea Group. Volatile stocks backed by weak earnings are known as black horses, while newly listed companies are called new horses.

White horse stocks are typically bought and held for an extended period, making them a difficult target for speculation, but the situation seems to have changed this year.

Kweichow Moutai shares hit a record high of 719.96 yuan on Nov. 16, climbing by a factor of 2.2 since the end of last year. Midea Group shares have nearly doubled from the start of the year to Wednesday, when they reached a year-to-date high.

The sudden rise of blue-chip stocks was prompted by U.S. index provider MSCI's official decision to include China A shares in flagship equity benchmarks in June. The announcement attracted institutional investors with index-linked funds in addition to retail investors looking to make speculative moves, as buying invites more buyers.

Popping bubbles

Chinese regulators have put the market on edge, however. President Xi Jinping has continued his campaign against speculative activities that lead to bubbles and crashes in financial markets.

On Nov. 17, the day after Kweichow Moutai's all-time high, Chinese authorities, through state-run media, called for restraint against speculative buying and announced new regulations for asset management by financial institutions.

Suspicions that the government will further tighten policy at this December's Central Economic Work Conference -- where next year's economic policies are drawn up -- are also raising doubts. Kweichow Moutai shares have declined by a total of 12% over six trading days as of Friday.

Securities that have been the hotbed of China's shadow banking sector are also being sold. And yields on China's 10-year government bonds have risen above 4% in mid-November for the first time in three years and one month.

Beijing is not drastically altering its tightening policy despite rising demand for funds before the year's end, popping bubbles while they are still small. China's economic indicators for October were generally weak as well, keeping concerns over a domestic economic slowdown alive.

This is likely to be a temporary correction, advised Zheng Xiaolei, head of Naito Securities' Shanghai office.

Overseas money

Despite the gloomy scenario, market participants in China and Hong Kong do not see the low stock prices lasting long. It is hard to imagine that the tightening will compare in scope to 2015, when regulators unmasked speculators and punished financial institutions, said Ye Shangzhi, a strategist at First Shanghai Investments.

Few also expect inflows of investor money to dwindle significantly. Although some of China's blue-chip shares have made large gains recently, the market does not feel overheated. The SSE Index has advanced just 8% since the beginning of the year, while Hong Kong's Hang Seng Index has jumped 35% and Japan's Nikkei Stock Average has grown 18%.

Foreign money will flow into China as investors around the world turn toward Chinese stocks made relatively cheap by the slump, Shanghai Securities News said Friday. Corporate earnings have also been brisk as January-September net profit for all Shanghai-listed companies increased 17% on the year.

In addition to an expanding consumer market, reforms at state-owned companies are also beginning to bear fruit, according to Value Partners Group, a Hong Kong asset management company, echoing investors who see conditions improving over time.

Chinese stocks are likely to remain volatile in the near future, caught between long-term growth prospects and near-term policy risks.

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