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China's retail investors are no suckers

Market commentators love to disparage them, but the people's eyes are wide open

THE securities industry just rained on China's bull market parade.

Stocks took their biggest tumble of the year on Friday as traders took a rare sell rating from the nation's largest brokerage as a sign that the government thinks the rally has gone too far.

On Thursday evening, Citic Securities Co advised clients that People's Insurance Co (Group) of China Ltd, a US$65 billion giant, could decline more than 50 per cent over the next year. Shortly after Citic's note, Huatai Securities Co cut its rating on CSC Financial Co, a fellow brokerage. Both stocks had more than doubled in value this year.

Separately, the state-owned China Securities Journal said in a front-page editorial that sell ratings must become "normal" in the future. Putting all these signals together, it's no surprise that traders rushed for the door.

The downgrades dominated Chinese financial media on Friday. But remarkably, no outlet has given any in-depth analysis of why these two state-owned businesses are such stellar performers. If you sift through Citic Securities' sell report, it's all praise for PICC's business operations - except for a brief paragraph stating that the company's price-to-book valuation is too high.

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What's unspoken is the most interesting part. There are good reasons for insurers and brokers to be rallying. Insurance companies have huge stock portfolios, so gains in the wider market are prompting investors to re-evaluate their worth. Brokerages, meanwhile, are beneficiaries of trading volume that's been exceeding one trillion yuan a day. In February, the combined net income of 34 brokers jumped 53 per cent from a month earlier, according to the Securities Times.

Even in this environment, PICC and CSC Financial have stood out, though. Before Friday's slump, PICC's Shanghai-traded shares were up more than 120 per cent this year, while those of CSC Financial jumped by more than 230 per cent. By contrast, their Hong Kong-traded H shares haven't joined in the frenzy.

To understand why mainland investors have favoured these two companies rather than industry leaders such as China Life Insurance Co or Citic Securities, look at China's distorted IPO system. PICC and CSC Financial are new arrivals to the A-share market, selling stock in November and June last year respectively. As a result, both will have tiny amounts of stock available for public trading (the so-called float) in the foreseeable future.

PICC is majority owned by the Ministry of Finance, which guaranteed that it wouldn't sell any shares for three years at the time of the listing. The national Social Security Fund, which holds 10 per cent, agreed to a one-year lockup. Public investors own only 2.3 per cent of the insurer's total shares.

It's a similar picture for CSC Financial. Key shareholders Beijing State-Owned Assets Management and Central Huijin Investment Ltd, which own about one-third each, also promised not to sell shares for three years at the time of the broker's listing.

It's simple supply-and-demand economics that a smaller amount of available stock will lead to an exaggerated move in price - both on the way up and, potentially, on the way down.

As I've written, insider selling rather than shadow margin financing is the key factor to watch in this bull run. More than 350 companies have filed planned share-sale disclosures with the Shanghai and Shenzhen stock exchanges this year. Business insiders, such as founders and parent holding companies, still own most of China's US$6.4 trillion stock market. Once mass-selling starts by these shareholders, the rally is over.

Individual investors are buying PICC rather than, say, state-controlled rivals such as China Life because they worry that the government may be tempted by the bull market into selling more stock. Seen in this light, PICC is a safer bet because of the lockup agreed by the finance ministry.

Market commentators love to disparage China's retail investors, calling them "chives waiting to be harvested". On the contrary, the people's eyes are wide open. BLOOMBERG

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