Recent Intervention Helping the Shanghai Composite

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 |  Includes: CAF, FXI, GXC, PGJ
by: David Enke

The Shanghai Composite has swung from 3,000 to 6,000, and back to 3,000 in a little over a year. To help curb the sell-off, the exchange instituted new rules to restrict large share sales by controlling investors, putting them in a 30-day lockup window, further reducing the amount of new shares and dilution hitting the market.

China is now going further by reducing the stamp duty, or stamp tax, charged on share sales. The tax is being lowered from 0.3% to 0.1% in an effort to reduce buying cost, and increase interest in share purchases. Just last May China and the index did just the exact opposite, raising the tax from 0.1% to 0.3% in an effort to cool a market that was beginning to look overheated.

Not surprisingly, the market liked the recent move and tax reversal as the Shanghai Composite posted a 9.3% increase during the session after the news, and is now trading above 3,500. In addition to the overall increase, over 200 shares hit the daily 10% limit imposed by the index.

Does the reduction in stamp tax increase trading? Yes, but somewhat indirectly. By paying lower fees, investors have more funds to purchase additional or new securities. One estimate has investors saving 120 billion Yuan over the next year alone, with an expectation that some of these savings will make their way into the market.

Of course, with higher return usually comes with higher risk, especially when the move is driven by intervention. As the Shanghai Composite index has just illustrated, both risk and opportunity can come from the same source, but in unexpected ways, and at unexpected times, irrespective of our view of the fundamentals.

As a side note, many of us jump into an international index without really knowing what we are investing in. For instance, consider the S&P 500 Index and Nasdaq Composite. Proxies for their markets? Sure. But it is important to know what these markets represent.

For the China market, shares of PetroChina (NYSE:PTR) represent about 20% of the Shanghai Composite index value. After reducing the stamp tax, and with a little help from oil prices, shares of PetroChina increased 7.1%, contributing a good deal to the move of the index. Being levered more to oil may not be a bad thing, but it is important to make sure we know what is inside the package we are buying, and whether this makes us more or less exposed to a specific sector or industry. Of course, hoping that any expected or unexpected market intervention will be best for our position is something we have a little less control over, even if we “understand” the market.