China’s Stock Market (Part 1): Where do all the Savings Go?

China’s stock market has been among the best performing in the world over the past several years. The Shanghai Composite Index has quadrupled since mid 2005, attracting attention from around the world and raising the questions: “Why is this happening? Can it last? Is this a bubble? How do I get in?

While China’s stock markets are well covered in the media, our website would not be complete without at least some commentary on the subject. As with most issues relating to China, it is easy to get caught up in the details and to make the issue extremely complicated. Understanding China’s stock market is no different. However, I’ve found that the simplest explanations are often the best, and that’s what I will try to do in giving our spin on this subject.

As everyone knows, prices of stocks, like the prices of most anything, are a function of supply and demand. The higher the demand and the more limited the supply, the higher the price, and vice versa. The first step in understanding China’s stock market, therefore is to answer the most basic question “Where is all the demand for shares coming from?” The answer lies in China’s savings rate, which at approximately 50%, is one of the highest, if not the highest, in the world.

“Where does this huge amount of savings go?”Because of restrictions on taking money outside China (the renminbi is not “convertible”), Chinese citizens actually have a limited range of investment options. A great deal of savings are put into bank deposits, even though interest rates are low at about 3%. Bank deposits are considered safe, because everyone knows that the government stands behind the state-owned banks. Over the last five years, more and more Chinese are investing in real estate, buying apartments for their own use, and even buying additional units to rent to others. That is one of the reasons why you see so many cranes inChina. The only other place that the Chinese have to invest their savings is in China’s stock market, and that begins to explain the reason for the huge demand for shares of Chinese companies.

According to the latest figures from the China Securities Depository & Clearing Corp. more than 400,000 new accounts were opened at brokerages on May 29, 2007, taking the total to 100.7 million, an incredible number. That’s one account for every twelve people in China! JP Morgan once said that he could tell when the market was at its peak when he began to get stock tips from the shoe shine boy. That meant that everyone that could buy shares was already in the market, and is a bit of what is going on in China.

Demand is one side of the equation, the supply of shares in which to invest is the other. What is the supply of shares? More to come.

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