China's A-Shares: A Roller Coaster Most of Us Aren't On

Russ Kinnel: Hi, I'm Russ Kinnel, director of manager research at Morningstar. Today, I'm joined by Andy Rothman, market strategist at Matthews Asia. I asked Andy to get on the line with us because I've been really interested in what's going on in China.

Andy, we've seen China's stock market this year have a tremendous rally, and then it sold off, essentially giving back its gains for the year, which really isn't that big of a deal. You see that all the time in markets. But what's interesting to me is China's reaction has been very strong. They are trying a lot of different measures to prop the stock market up. So, I'm kind of curious about why you think they are doing that. Do you think the measures are effective?

Andy Rothman: Thanks, Russ. It's interesting because, at this point, the measures have been effective in stabilizing things, so the China markets are actually not doing too poorly. If we look at the close of the market on the July 14, the main domestic index, the A-share Shanghai Composite Index, was actually up 21% from the start of the year and up 90% from a year ago. The MSCI China Index, which is more relevant to American investors because it looks at Hong Kong, that's still up over 4%, year to date, and over 10% from a year ago. So, that isn't quite the crash that some of the headlines make it out to be.

Kinnel: No, it isn't. One of the unusual aspects, I've noticed, of the market has been that hundreds or maybe over a thousand stocks in China have suspended trading. Can you tell us a little bit about why that is and when you might guess they will resume trading?

Rothman: Let me answer that by taking a step back first and saying that stock markets in China are pretty recent. They've really only been around in a serious form for just over a couple of decades, and it's still a pretty amateurish operation. They really panicked when there were some losses over the last few weeks. It's unfortunate and it's disappointing, but it's not really surprising. The government has manipulated markets and intervened like this pretty often in the past. I think it was unnecessary. They did get pretty panicked, but things have at least stabilized now.

Kinnel: So, does that mean that soon these stocks may resume trading? Have they communicated what the criteria are for returning to trading?

Rothman: Almost half of the companies listed on the main domestic board, the A-share market, suspended themselves. Remember, these weren't suspended by the regulator; it was the companies asking to be suspended to halt trading. Obviously, this was done simply because they were worried that their share price was going to go down rather than for any more substantive reasons. But within the last few days, more than a third of the companies that suspended themselves have unsuspended themselves and are back trading again. So, I think the process is moving back toward normal. The damage isn't going to be all that severe with regard to investors, but it does illustrate that this is still a market that's in its very early days--think the U.S. markets before the creation of the SEC in the 1930s.

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Kinnel: Another interesting aspect to me is that large owners of Chinese companies have been told not to sell their shares. That makes me wonder whether the price-discovery mechanism of the market is really working when big sellers are not there. If I buy in today, am I at risk of getting an inflated price?

Rothman: Well, it's interesting because the majority of shares in the A-share domestic market are held by large-scale investors--often the corporations themselves or some institutions that are connected to the government. But 80% of the turnover in that domestic market is from small-scale retail investors. That's where you've had these waves of changes in sentiment. The government is trying to put a floor under it with the institutions now. We don't know yet, but my assumption is that the government advice, requests, or orders to the large-scale investors not to sell are probably coming off, given that the market has stabilized in the last few days.

Kinnel: And if I buy today--though, in a way, that's not really even possible when you're talking about A-shares because those are largely limited to Chinese investors. So, let's take a step back and say, for U.S. investors and for Matthews funds, which have a number of funds focused on Asia, what does this mean? I assume these effects are more secondary than direct.

Rothman: That's right. For almost anybody listening to this, they are not going to have any direct exposure to the domestic A-share market. The Chinese have deliberately limited foreign exposure significantly. Foreigners own less than 3% of the market, so hardly any Americans are in there. American exposure to China is primarily through the Hong Kong-listed shares, and that's the same for us. Matthews Asia is the largest Asia-only investment manager in the United States. We have more than $30 billion under management [in the United States]--about 30% of that is in Chinese equities and almost all of that is not in the domestic A-share market that has had these roller-coaster rides.

Kinnel: So, looking at the investment universe that you face, which is largely not the A-shares, do these stocks look attractive? Obviously, the drama in the Hong Kong shares has not been as wild as the A-shares.

Rothman: That's right. It's been a lot less wild. For example, if we go back about a month ago before the correction in the A-share market, the median forward P/E in the A-share market was about 54. The median forward P/E in Hong Kong, however, where there is more foreign participation or institutional participation, was only 14. That's why, before the correction, the median forward P/E of all of Matthews Asia's China-equities holding was 17, which coincidentally was about the median forward P/E of the S&P at that time.

So, we've been much less on that roller-coaster ride because we've been trying to not only focus more on the Hong Kong market but also focus on the better-quality, reasonably priced Chinese equities that are out there. So, when the dust settles--and, frankly, I have no idea exactly when that's going to be--there is a good possibility that this is going to be a buying opportunity for us because we've had to trim some positions for companies we like that got too expensive; we have other companies that we've been keeping an eye on, waiting for a reasonably priced opportunity to get in. So, it may turn out that way.

Kinnel: Thanks so much, Andy, for joining us.

Rothman: Thank you.

Kinnel: I'm Russ Kinnel.