Red October

Chinese investors cope with harsh market realities.

Mr. Gong can’t help but gloat. Back in 2007, China’s stock market was on fire, and the 57-year-old retired engineer’s family was “crazy” to get in on the action. But the veteran investor was skeptical of the trading frenzy. “I told them to get out,” he says on a quiet November afternoon at Huahong Securities, a Beijing brokerage. “They didn’t listen.” Mr. Gong (he gave only his family name), sharply dressed with a wide smile and greying hair, sold the bulk of his shares when the Shanghai Stock Exchange was at 5,500 points, down from its peak of 6,124.04 in October 2007. He says he lost about 10% of his investment. His wife, who did not heed Mr. Gong’s warnings, lost more than 70% of hers.

She isn’t alone. Over the past 12 months, the Chinese stock market has imploded, shedding two-thirds of its value and leaving millions of retail investors, who once rushed into the game brimming with confidence, wondering what went wrong. By the end of October, in what was its worst month since 1995, the Shanghai index slumped to its lowest level in more than two years after worse-than-expected earnings from Chinese companies. The government, meanwhile, has implemented a flurry of measures to stem the bleeding, but analysts don’t expect the market to recover anytime soon. With a splashy Olympic Games and roaring economy, 2008 was meant to be China’s celebration. But for many investors, the Year of the Rat has become one to forget. The dismal situation is in stark contrast to just over a year ago, when China’s retail investors — including students, retirees, stay-at-home moms and Buddhist monks — plunged headlong into the market. People with scant knowledge of investing ignored warnings of a bubble and in some cases piled their life savings into massively overvalued stocks. In 2006, the Shanghai index soared 130%, and doubled the following year. At the peak of the hysteria, China’s “A” shares of listed companies were inflated to a premium 100% higher than “H” shares of the same companies on the Hong Kong exchange. China boasted five of the world’s 10 biggest companies by market capitalization.

How times have changed. Today, the Shanghai index hovers around 1,900 points, and the country’s once vibrant, casino-like brokerages are nearly void of life. At Huahong Securities, Mr. Gong was joined by just one other day trader; a dozen rows of brand new computer monitors sat empty. The stock market’s demise is largely due to falling company earnings, says Chen Li, China equity strategist for UBS Securities in Shanghai. And things look to get worse before they get better. In the first quarter of 2008, earnings growth for Chinese companies was at 44%. In the second quarter, it dropped to 7%, and by the third quarter was down to –18%. Chen expects earnings growth to bottom out in the first quarter of 2009 at about –30%, and then begin the slow path to recovery.

Investors, meanwhile, are angry, prompting security concerns in a security-obsessed nation. In June, for example, a small group of investors demonstrated outside the Shanghai Stock Exchange. The government has moved into damage control. At the end of September, it launched a rescue package, including a pledge to use government money to buy listed shares, which sent many stocks up the maximum 10% the day of the announcement. The finance ministry announced policies that encourage big state-owned companies to buy back shares and, toward the end of October, said it was scrapping a tax on capital gains for individual stock accounts. This fall, the government cut interest rates three times in six weeks.

The measures are of little consolation to burned investors. Xin Yuan, 26, an unemployed teacher who began playing the market in March 2007, has seen her investment plummet. Her father, an employee at a Beijing water company and avid trader himself, had given Xin 140,000 yuan (about $24,000) to put in the market, which she grew to 240,000 yuan by the end of last year. Then the shares started to fall and Xin began “cutting flesh,” a Chinese term for selling at a loss. Her investment has now dropped to 90,000 yuan. Xin, who spends about four hours a day on her computer trading and researching stocks, is trying to dump her expensive shares and buy cheap ones. “If you don’t do anything, your stocks won’t grow,” she says during an interview at a Starbucks in downtown Beijing. When asked if she wishes she had pulled her money out before the market tanked, she shrugs: “It’s not useful to regret. Maybe the market will drop and then go up. I think it can get better one day.”

Analysts urge prudence. UBS’s Chen expects the market to hit bottom around December and then begin a slow upward climb. He says the government can do its part by targeting some of its recently announced US$586-billion economic stimulus plan toward boosting company earnings. “As earnings growth increases, investors will become more optimistic,” he says. “But I do not think the market can return to over 3,000 or 4,000 points” in the near term.

Sitting in his office overlooking a smoggy Beijing afternoon, Liu Boshu, a stock and real estate analyst at Huahai Futures, mulls over stock performance charts comparing the Shanghai index to other exchanges. Like the Nasdaq exchange, which has never fully recovered from the bursting of the tech bubble, Liu says the glory days of China’s stock market are over. Thanks to the global financial crisis and China’s economic slowdown, he expects it to continue to struggle for the next two to three years — at least. “It’s like a patient just released from the hospital,” he says. “It will take time to recover.”