Liu: A Guide to Chinese Stocks

We've seen bulls, we've seen bears. Now we're seeing pandas. The startling lesson from Tuesday's tumble by Chinese stock markets, the worst in a decade—and the subsequent tumult in major markets across the globe—is the intensity of foreign interest in Beijing's economic health. In fact, the performance of Chinese markets is linked only idiosyncratically to the wellbeing of the Chinese economy. But that didn't stop the bears from rampaging worldwide when the Shanghai index dived 8.8 percent, just a day after topping the psychologically important 3,000 mark. The downturn was equivalent to a 1,100-point drop in the Dow Jones industrial average.

What precisely is this exotic new animal? On Wednesday, the Shanghai composite index was just about the only major Asian market to rebound. It bounced back nearly 4 percent—reaching 2,881.07—and the mood among investors in one stock-trading center in Beijing was remarkably sanguine. More than 200 citizens crowded into the Yue Tan branch of the China Galaxy Securities firm in Beijing on Wednesday afternoon, some of them pedaling up on bicycles. Along one side of the hall, many sat staring at the blinking big board. A red banner strung from the ceiling of the hall exhorted Follow the law and protect the interests of investors.

One of those investors is Xiong Guang, a leather-clad sardonic stock veteran for whom individual prices and big international names such as Warren Buffett roll easily off the tongue. He declares, "China's stock market is quite different from that in the U.S. Here both clever people and fools invest." Although he says most investors are retirees and "more than half are losing money," that hasn't stopped him from buying more shares both Tuesday and Wednesday. He's hanging around to see if the index dips to 2,200, at which point he intends to buy much more. His favorite: Cheng De Vanadium and Titanium, because "in China you can't go wrong with mineral resources."

Tuesday's stock slide was triggered partly by reports that the cabinet had set up a special task force to investigate questionable bank lending to stock buyers, and partly by rumors that the Chinese government was about to spring a 20 percent capital-gains tax on stock buyers. But nothing fundamental had changed in China's economy. And market sentiment warmed up again after authorities denied they would implement the capital-gains tax and state media cited Premier Wen Jiabao as saying the government would focus on ensuring financial stability and security.

After Tuesday's wild ride, one local wag dubbed the Shanghai index a "panda market," meaning one which everyone's watching intently now, even if they don't know what its ups and downs mean. So what makes it tick?

Rule No. 1: What happened Tuesday proves how closely foreigners are tracking the health of the Chinese economy—but it doesn't mean the Shanghai index has become inextricably linked to markets everywhere else. In fact, regulations limit foreigners' ability to buy yuan-denominated A-shares, which make up the lion's share of Chinese markets, and capital controls make it difficult to move money from mainland markets elsewhere. "Yesterday suggested to some that China's stock market and the world's are now fundamentally linked. Today's action pours cold water on that theory," wrote Stephen Green, a Shanghai-based economist with Standard Chartered Bank, in an e-mail after Wednesday's rebound in China.

Rule No. 2: Many Chinese stock investors still have faith in their economy (and besides, in the wake of government efforts to cool down an overheated real-estate sector, there aren't many other good investment options around). "There's no need to worry," says Wang Zhongjie, a dapperly dressed former government cadre, as he watched the board at the Yue Tan trading center. "The economic situation is getting better and better." He says he's put about $70,000 (U.S.) into stocks, partly because bank interest rates are too low. What about real estate? "A few years ago I did buy an apartment for about $80,000—with money I made on the stock market."

Rule No. 3: That faith doesn't always translate into confidence in government officials or big institutional investors. Parked in front of a computer terminal, a trim 50-year-old woman named Zhang Yuxiu says she's been playing the market since 1995 and has invested about $128,000 altogether. She shakes her head and grimaces at the memory of the last time stocks took a precipitous dive, back in 1997 during the Asian financial crisis. "At that time the government didn't bear responsibility to investors," she says. "[Former premier] Zhu Rongji didn't do a good job. Many bad stocks were made to look good—wrapped in pretty paper—to attract ordinary investors. But then big investors sold shares to make a profit, and ordinary people lost out." Her hot picks: "Metals, petrochemicals and real estate used to be promising—but beginning this year, agriculture and telecommunications are good."

Rule No. 4: Insider trading really isn't all that bad. Many ordinary citizens believe everyone's doing it. Some even seem to think that if you have a friend with a cousin with a girlfriend working in an important government office, well, how can you not be in the market? "You need inside information to do really well; the stock market is set up to benefit people with good connections," says one former investor who sold all his stocks during the Chinese stock market slump a few years back and has no intention of jumping back in. He says investors can and do get away with insider trading all the time.

Rule No. 5: Don't believe everything you hear. Precisely because inside connections are so important to China's business culture, vague gossip—such as tax rumors—can move Chinese markets to a startling degree. At the end of Wednesday's trading session, a young man behind a desk in the hall gave a little "stock markets for dummies" lesson over the public-address system, in an apparent attempt to educate some of the individual investors milling about the floor. "Just because you see a lot of people here today, don't believe those who say there are many more investors putting money into the market," he explains patiently, "The reality could be just the opposite." Some citizens listen intently; a few others played Chinese chess on portable boards spread on the marble floor.

China's stock markets are still immature. While foreign strategists have every reason to be concerned about whether the country's economy is slowing—it grew 10.7 percent last year—the Shanghai composite index is not the best gauge. Indeed, before the index exploded by 130 percent in 2006, it had languished in the doldrums for half a decade even as GDP growth sizzled each year. Chinese corporate culture can be counterintuitive as well. When mainland firms announce what would be seen as bad news in the West—say, being cited for misappropriating corporate funds—their stock prices often skyrocket (because their management and bookkeeping is bound to improve, or so Chinese investor logic goes). Stock market behavior in more developed countries is easier to analyze. Understanding the panda market isn't as black and white as it seems.