In 2015 and 2016, huge price swings made China’s stock market seem like a casino. One reason for the volatility was that the market is thinly traded. Only 7% of China’s population own stocks. Since participation is so low, a few wealthy investors own 80% of tradable shares. They drive the price swings in China’s stock market. China’s leaders encourage investment as part of economic reform. A healthy stock market will fund innovative smaller companies and boost China’s economic growth. It would provide an alternative to bank debt. As an attempt to curb volatility, China’s Securities Regulatory Commission established automatic circuit breakers in January 2016. The Commission withdrew the breakers after only four days, because they only made things worse. Unlike the U.S. stock market, China’s stock market doesn’t indicate the health of China’s economy. The total value of every stock traded on its exchanges is less than a third of its economic output, as measured by gross domestic product. That compares to 100 percent for most developed countries. In China, less than 20 percent of household wealth is in the stock market. Instead, most are fully invested in real estate. Banks only offer low interest rates on savings accounts, since the central bank keeps rates low to make lending cheap.
China’s Stock Exchanges
There are two exchanges on the mainland. The Shanghai and Shenzhen exchanges were opened by the Chinese government in 1990 as a way of modernizing China’s economy. The Hong Kong stock exchange is being integrated into the other Chinese exchanges. That makes the HKEx loosely part of China’s stock market. The Shanghai stock exchange is China’s largest. Its total market capitalization was $4.1 trillion in 2016. Most of the companies listed are the large, state-owned companies responsible for China’s economic growth. Most investors are pension funds and banks. The SSE is located in Shanghai, China’s financial capital. The Shenzhen stock exchange is a smaller exchange. Its market capitalization was $3 trillion in April 2015. The SZ is in Shenzhen, Guangdong, one of China’s most modern cities. It’s a two-hour drive from Hong Kong. Most investors are individuals. The Shenzhen trades the shares of smaller, more entrepreneurial companies. Their growth is a critical component of China’s economic reform. These privately owned businesses are more innovative and more profitable than the state-owned companies. Many tech companies are listed there, making this exchange similar to the NASDAQ.
Compare Shanghai to Shenzhen by Sector
In November 2014, the Chinese government linked the Shanghai exchange with the Hong Kong exchange through the Shanghai-Hong Kong Connect program and added the Shenzhen market in late 2016. The Connect program allows foreign investors to buy shares of Chinese companies. Prior to the program, only Chinese citizens and a few foreign fund managers could trade mainland China stocks. Chinese citizens are allowed to trade up to $1.7 billion per day. It also encourages Chinese savers to buy stocks and earn higher returns. Part of President Xi Jinping’s economic reform plan is to help heavily indebted state-owned companies. Higher share prices allow them to raise cash in the stock market. Many companies are now listed on both the Shenzhen and Hong Kong exchanges. Stock prices are often lower on the Hong Kong exchange than on the Shenzhen. That attracts mainland investors.
China Stock Indexes
The Shanghai Stock Exchange Composite Index tracks the Shanghai exchange. SHCOMP does this by tracking the daily price of A-shares and B-shares weighted by the total number of shares issued. Price changes of larger companies affect the index more than those of smaller firms. That means it is a capitalization-weighted index, like the Standard & Poor’s 500. The Shenzhen Index tracks the stock prices of all A-shares and B-shares on the Shenzhen exchange. SZCOMP is a capitalization-weighted index. The Hang Seng Index tracks the Hong Kong stock exchange. HSI reports the prices of the largest and most frequently traded companies listed on the Hong Kong exchange. No company can represent more than 10% of the index value. Like the Shanghai index, it weighs the share prices by the number of shares. It also weighs the values by a free-float factor. There are four sub-indices: Commerce and Industry, Finance, Utilities, and Properties.
History
China’s first stock exchange opened in the 1860s in Shanghai. It closed for 41 years during the Cultural Revolution. In 1990, the Shanghai Stock Exchange re-opened. Private investors bought shares of state-owned businesses.
