Chinese markets fell Wednesday as macroeconomic concerns plagued the market. The Shanghai Composite fell 17.64 points, or 0.89%, settling at 1973, well below the psychologically-important 2000 level. Hong Kong (EWH, quote) did not fare much better, closing down 0.62%.
While Chinese market fundamentals appear to be improving, as companies become more attractively priced and manufacturing data indicating that growth may be returning to the beleaguered sector, the stock market remains depressed. The Shanghai Composite remains in a prolonged downtrend having lost 17% this year and 60% over the past five.
Although this prolonged slump may seem irrational in light of improving fundamentals, there is a compelling reason for this continued underperformance. As a result of myriad accounting scandals and opaque accounting practices, the Chinese populace as a whole have lost their collective faith in the country’s stock market. Until new regulations are implemented that increase transparency and companies take investor relations more seriously — many firms do not pay regular dividends — wealthy Chinese will continue to pour money into other asset classes.
This trend has been troublesome for brokerages like CITIC that depend heavily on stock transactions to achieve profitability. The company has lost 24% of its market capitalization over the past six months. As reported in Bloomberg, ”regulatory data showed the number of stock trading accounts that made transactions last week was the lowest since at least January 2008, excluding holidays.” The news sent CITIC 1.4% lower for the day.
While valuations in many Chinese equities are quite compelling at these levels, investors would be wise to get their Chinese exposure through vehicles not tied directly to the Mainland Chinese markets. Large-cap Chinese stocks listed in Hong Kong or as ADRs in the United States are likely to outperform their mainland counterparts until the abovementioned structural concerns are remedied.