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Kill Your Horses

Written by Brian Hicks
Posted December 20, 2005

There are few things I find more frustrating than a bad metaphor. Figurative language has the ability to make one sound educated, insightful, and even original.

Similes and such can be brandished as rapiers or fall as flaccid as a Nerf saber. Here's a piece of English pseudo-wit that people unfortunately LOVE to use:

"Don't change horses in midstream!"

But what if the horse has gone lame? What if the stream is shallow enough to wade across and you could buy a new horse? Why on earth does this logical gravel pass through people's notional sieves unsifted?

I prefer to invoke a different equine example: the Horse Latitudes.

During the Age of Exploration, when steel-capped conquistadors sailed around the known world looking for the "new" one, they found that in certain stretches of open ocean they couldn't catch a stiff breeze to save their lives.

Geographically, the Horse Latitudes are the Calms of Capricorn and the Calms of Cancer.

Air sinks towards the earth's surface in these areas, eliminating the high, whipping winds needed to power sails.

Sailors were forced to eat the meat and drink the blood of their own horses to survive, and dump the carcasses overboard to drop weight and hopefully get going again.

China's mainland stock markets are stuck in the Horse Latitudes, and they will have to make meat and lose some weight, or else they will die.

You Are the Weakest Link, Goodbye!

Since I started the Waking Dragon newsletter a few months back, people have asked me why I never recommend investment in the Shanghai and Shenzhen exchanges.

The Economist lists a -10% change in the Shanghai exchange since last December 31 (-8.3% in dollar terms). Compare that to the other regional economic juggernaut that usually gets mentioned in the same breath as China: India.

India has experienced a positive 42.3% change in its benchmark index (+37.5% in dollar terms). Its market stands at above 9,000, while China's healthiest index is a hair below 1,200.

A recent survey of 2,671 small and medium-sized investors conducted by the China Securities Journal found that 77 percent of investors in the Shanghai and Shenzhen markets lost money this year. Only 12% turned a profit, and 11% managed to break even in the end. Not too rosy a picture considering GDP growth of 9% a year.

But there is good news. State media reported Wednesday that China's stock exchanges will soon be given the power to list and de-list companies in order to regulate the overall health of the markets. This is a shift from the former policy of direct listing control by the China Securities Regulatory Commission.

Under the existing regime, a foundering company with a listing on Chinese exchanges could avoid delisting if the owner or manager had a buddy or enough guanxi (favor balance) with someone on the regulatory board.

Analysts estimate that there are between 300 and 400 companies like this listed in Shanghai and Shenzhen despite any known economic logic. This is cronyism in its purest form - and it has to stop.

The new rules, when they take effect, will require the kind of transparency and accountability that make any stock market worth its salt. Without SEC filings and mandatory transaction and investment reporting, American exchanges would be based on nothing but good faith, and that's no way to run an economy.

Of the respondents to the CSJ survey, only 1% said that they were willing to boost their mainland stock investments in the coming year, and a full 25% said that they planned to pull their money out entirely. Yikes.

The hundreds of firms on life support in China are value killers. They are the proverbial bad apples, and they are spoiling the bunch. They must be thrown out.

Hopefully, these new rules and their effects will raise the confidence of Chinese investors and, in turn, us here abroad. Until the canary has successfully descended the coalmine, though, I advise you to stick to American Depositary Receipts (ADRs), a convenient way of buying into Chinese companies without assuming all of the risks of Chinese stock markets.

Also, I will be highlighting other Asian exchanges in the coming months as viable options for safe, China-based trading. Hong Kong's robust exchange is the perfect example of a forum where Chinese companies list in droves without subjecting themselves to the whims of Shanghai and Shenzhen's adolescent trading culture.

Sam Hopkins


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