What Explains the Chinese Stock Market Price Boom?

The Chinese stock market boom has been scrutinized by the US mainstream media for it’s rapid ascendance. You will hear people mentioning that high school dropouts are now investing in large numbers without understanding the basic fundamentals of companies including but not limited to earnings. The Hang Seng (Hong Kong’s Market) has risen 60% this year having been opened up to sell shares to Chinese investors.

In all reality, small scale investors make up a small portion of actual market volume – and while it’s true that a large number of them are trying to get in on the action, the real reason for this steep rise is a law change which hampered real estate investment tactics. This included increasing the minimum down payment on a second property to 20% and increasing the capital gains tax on property sales to 20%. If you’ve lived in Asia you will find out that Chinese investors are big into real estate – and this spreads beyond China and Hong Kong into other ASEAN countries including Australia and New Zealand. Even less educated folks know the value of owning property, and many of them have been fortunate to make a reasonable amount of money in the past few decades as China has progressed to claim the world’s #2 spot economically speaking.

Stack the new property restrictions with two interest rate cuts by the central bank and a specter of a stimulus package down the road and you have the perfect environment for a stock market to flourish. This is similar to how the US stock market has reacted in the past few years to the Federal Reserve stimulus packages and extended periods of historically low interest rates.

Just this week, the Hang Seng market value rose above Japan’s Nikkei – an amazing feat but not unexpected given their market getting opened to Chinese mainland investors. Japan continues to stagnate as its fundamentals and workforce are burdened by a low growth rate and near zero immigration (due to strict immigration laws). The one bright side to the economy these days is higher tourism due to a stronger dollar against the Yen.

Some imagine the Chinese and Hong Kong bull markets will continue for awhile until free cash flow diminishes. Others are more skeptical, including most US pundits – they envision a large correction. I can foresee a huge catastrophe if the tax laws are changed regarding Chinese capital gains tax on stocks, but given the new restrictions on real estate trading this isn’t completely out of the question.

In hindsight, an American investor could have made a fair amount if he/she invested in Matthews China Fund Investor Class (MUTF:MCHFX), which has gone up 20.17% Year To Date. This fund specifically zoned in on Chinese stocks has outperformed one of the best American stocks Apple (Apple has gained 12.96% year to date) and NASDAQ (A piddly 4.57%). Investors can also consider investing in a broad array of Asian dividend stocks using the Matthews Asia Dividend Fund Investor Class (MUTF:MAPIX) which has gone up 12.95% YTD.

It goes without saying that the one who thinks there’s a serious bubble can always short these types of securities, but this is EXTREMELY risky. There is still more free cash flow as a percentage of the stock market capitalization in China than the US, meaning that they can pump a lot more money into the stock market before running short on liquidity. My expectation is that if the Chinese stock market is reaching bubble capacity and collapses, it’s quite likely to impact the US stock market. Even from a psychological perspective, seeing a bubbled stock market pop may cause people to rethink their investments.