What Was Behind China's Sell-Off?

02/28/2007 12:00 am EST

Focus:

Robert Hsu

Editor, China Strategy and Asia Edge

Long-time China bull Robert Hsu, editor of China Strategy, goes behind the scenes of the Shanghai market’s meltdown and explains why he thinks investors should sit tight.

The Mainland Chinese stock market in Shanghai had its biggest one-day sell-off in ten-years Tuesday with a 9% drop. (This came on the heels of an all-time high close the previous day.) Mainland Chinese companies trading in Hong Kong fared better with a 3% drop, holding at a key support level of 9,500, while the general Hong Kong market was down only 1.7%. (Hong Kong’s Hang Seng index fell 2.5% Wednesday, in line with much of Asia, while the Shanghai Composite index rebounded almost 4%--Editor.)

What caused the sell-off in China last night?
1. Speculation that the chairman of the China Securities Regulator Commission (China's SEC), Shang Fulin, may leave his job soon. Mr. Shang is the chief architect behind Mainland China's capital market. I believe that these rumors may be exaggerated, and even if he does leave, the reforms will continue in the Shanghai stock market.

2. Talk of aggressive interest rate hikes in China to slow down the economy. For this year, I expect probably two more interest rate hikes, which won't derail the long-term trends we're profiting from.

3. There is also talk about collecting capital gain taxes on Chinese mutual fund investors. Stock market investing and trading gains in Mainland China are tax-free at the moment. Regulators have clearly said that the tax will not be implemented any time soon.

4. A lot of the selling we saw can be attributed to general profit taking after a major run-up. Some large institutional shareholders of giant Chinese state-owned enterprises (SOEs) are taking profits after the recent rally. From a technical standpoint, the 3,000-level in the Shanghai A Share Index is one of strong psychological resistance, and after last year's 130% run-up, the market needs to flush out some weak investors before the rally can resume.

I've always been more cautious regarding the Mainland Chinese Shanghai A Share market because of the high valuation and poor quality of the companies listed there (most of which are SOEs). But the fact remains that Chinese investors have very few options to earn good returns on the $3 trillion they've saved up in their banking system. This will not change any time soon, so I don't expect China's markets to collapse.

Tuesday's selling in our China ADRs like China Mobile (NYSE: CHL), China Aluminum (NYSE: ACH) and Sinopec (NYSE: SNP) already factored in an additional 3% to 4% sell-off.  (All of them were up in Wednesday morning’s New York trading—Editor.)

So for the moment, just sit tight. My hunch is we'll be getting some good buying opportunities.

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