Long lines, forgotten passwords, and all-star mother-in-law money managers-China's Investment Environment

If you spend enough time in China, you learn fairly quickly the "herd mentality" abounds. It is evident everywhere, restaurants/ticket counters/kiosks/brokerage lines/ect. The Chinese are big believers that where there is a line (or crowd), there must be something worth waiting for or worth seeing. Maybe this is why there constantly seems to be droves of people pushing to get "an edge." Receiving a shove in the back is never personal, it is just a friendly reminder that you better pay attention, because someone is there to capitalize if you don't. It is a real "hustle" attitude which fits nicely with the idea of free markets and "no free lunches." It matters less if there is really an substance behind what seems to be so sought after, rather the perception of substance is enough to draw crowds. At Starbucks, are coffee beans, hot water and a frothy top really intrinsically worth $4? Maybe not, but that is irrelevant. The marketing folks at Starbucks have done a text-book job of convincing people it is worth the price.

After lingering in the abyss since 2001, China's A-share stock market returned 130% to investors and speculators alike in 2006 making it the best performing market in the world. The A-share market is already up another 10-15% in 2007. Now, do the companies behind these stock tickers actually justify such valuations? It is hard to say for sure, because reliable company financial data is extremely hard to come by in China. If one cannot trade based on reliable fundamentals, that only leaves one option: technical trading.

Stocks in China are largely traded a physical brokerage locations or over the phone. Online trading is still relatively new in China, but will likely gain traction in future years. Due to the "can't miss" investment opportunity that is the A-share market, local Chinese are rushing to open accounts at breakneck speeds to get a piece of the action. By some estimates, as many as 70,000 new accounts are opened daily. With the release of Qualified Foreign Institutional Investor (QFII) regulation last year, foreign investment capital was allowed to flow in to the A-share market for the first time.

While foreign individuals (such as myself) are not allowed to open brokerage accounts in China, a quota of approximately $11 billion allowed to be invested in China's stock market was spread across 50 foreign institutions. Billions more is waiting at the door itching to rush in. Given the fact there is already excess liquidity sloshing all around China and, in the interest of not having the market spike 1000%, the flood gate will be opened slowly to foreigners. Historically, most Chinese lacked many investment options, as the average "Joe" or "Li" isn't allowed to invest abroad. Average people could choose to leave their money sitting in a bank account (where approx. $2 trillion sits today) earning 1.5% or take their chances in the local equity markets. Presently, the equity markets are perceived as more legitimate than before as better quality companies are choosing to stay at home a list locally, taking advantage of the liquidity, and regulations are being more actively enforced. Almost 1/2 of the companies listing in Shanghai last year, were already listed abroad in markets like Hong Kong. As a result of the perceived value, regular people are getting in.

I sometimes hear local people complain they had an off year because their portfolio only returned 70% in 2006. Granted, they missed replicating the overall index, but there are people running hedge funds and investment firms all over the world that would call a 70% a better than average year.

At a dinner I attended the other day, a Chinese friend (who had spent 5 years abroad) told me how nervous she was investing in the local market. She told me last week she made a trip to a local brokerage house to execute a trade. While she was waiting in line, a man, who by her estimate was around 80, starting flipping out. During the 1990s this would have been interpreted as normal, because brokerage houses in China were the equivalent of bingo halls in the US. They were a place where retired people went to pass the time and throw some money around never really expecting a return. To them, it was the price of entertainment.

As it turned out, he was throwing a fit because he had forgotten the password to his brokerage account, so he couldn't make the trade he wanted when he wanted. Her words were, "if he is representative of who is investing in the market today, things are getting way out of hand." The present investment environment in China is symbolic of the mania of the late 1990s that swept across the US. Many people said, once my barber starting getting into the tech game, they knew it was time to liquidate. Maybe we should tailor that statement to read, "once the 80 year old guys forgets his password and flips out in the brokerage house, it is time to get out or at least take a knee for a while."

One of my coworkers' mother-in-law is managing a portion of he and his wife's money. Now, it would be one thing if she was an experienced trader or money manager, but she is neither. She doesn't even know what company financial statements are or anything about investment multiples or sophisticated analysis techniques, which might be just as well given local conditions. Her investment strategy is "never invest for the long term in China's stock market." This might sound crazy, but it is highly logical given the volatile roller-coaster ride that epitomized China's markets during the 1990s. She returned in a measly 35% return last year because, in his words, "she's too conservative." I advised my coworker to fire his mother-in-law as his money manager and run down one of the 80 year-old guys down at the brokerage house to take over, preferably one that can, at least 7 times out of 10, recall his/her password. He thought that wouldn't be a good move given the "probable less than desirable implications on the home front."

Moral of the story: well, there isn't one. It is just a very interesting time in the wild wild east where long lines, forgotten passwords and all-star mother-in-law money managers tell you all you need to know about the state of the local markets.