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Derailing the through train

By Jim Trippon

Three years ago the China investor community was buzzing about a proposal called the “through train” in Chinese. Longtime China Stock Digest subscribers will remember the excitement it caused.

Now, after protracted policy shifts and delays, we can say for certain that the investment Through Train to Hong Kong is officially off the rails.

The proposal would have created a trial program to allow mainland Chinese investors to invest their money directly in securities listed in Hong Kong. Other overseas markets were also being considered as investment targets.

The idea caused a huge stir at the time. Shares of Chinese companies traded in Shanghai were selling at huge premiums compared to shares of the same companies listed in Hong Kong, or traded in New York as ADRs. Beijing was worried that Shanghai was in a bubble and hoped to cool the market by allowing arbitrage – a leveling out of Chinese share prices worldwide through open trade.

But Beijing’s hopes of cooling the Shanghai Stock Market caused investors in Hong Kong to expect a flood of money to rush in. Excitement over a potential surge of mainland cash into Hong Kong stocks helped send the Hang Seng Index up about 55% from an August low to an October high in 2007.

That high of more than 30,000 for the Hang Sang set a high which has not been equaled to this day. The Hong Kong benchmark index slumped when Beijing wavered on the through train proposal. Then the global financial crisis hit, dragging down Shanghai and Hong Kong in tandem with crashing stock markets around the world.

Beijing was no longer worried about a bubble bursting in Shanghai and the through train proposal languished for three years. Now that Hong Kong has rebounded and Shanghai has soared, Beijing has officially responded by dropping the through train idea altogether.

What can we read in the tea leaves from this decision? First, that Beijing is not worried about a bubble in the highly valued Shanghai stock market. Shares in Shanghai still trade at a premium in Shanghai compared to New York and Hong Kong prices but China seems unconcerned.

Second, Beijing is also showing confidence that China’s economic performance can be sustained and that there won’t be a sharp correction in Shanghai during 2010.

Since 2000, China’s government has operated with concern that Chinese investors might be harmed by sharp stock market corrections. (In the early days of Chinese capitalism chaotic market conditions lead to some very angry demonstrations by investors.)

Now share price changes in Shanghai are limited to moves of no more than 10%. No such safeguards exist in Hong Kong. Instead, Beijing is signaling that it could permit market mechanisms, possibly including shorting or derivatives to ease internal market pressures and let the steam out of speculative stocks.

The through train is dead, but Beijing is instead allowing more foreign investors into Shanghai. And it is seeking new ways to let Chinese invest abroad in an ongoing effort to end the former global isolation of the Middle Kingdom.

We believe that China’s investment reserves will eventually find their way to global markets.

Jim Trippon,
China Stock Digest Editor-in-chief

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