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By Yi Xianrong

When investors cheered as stock indices looked as though they would turn bullish not long ago, this author cautioned that investors, particularly small and medium-sized ones, should keep their cool in the face of this "windfall."

This is because the basic infrastructure of the Chinese stock market remains largely the same, despite the reform that was carried out in this field. In other words, the overhaul of the stock market is proceeding slower than expected. The stock market's deep-rooted defects are to blame for the fact that some listed companies sold junk shares at high prices, the interests of the investors were not duly protected and the market lacked credibility.

All this, in the final analysis, is due to the absence of a trading platform based on fairness and transparency, effective price-setting mechanisms driven by market forces and a compensation mechanism designed to protect investors' interests.

But the establishment of a sound and workable system takes time, despite the fact that the splitting of tradable and non-tradable shares and the Measures on Management of Listed Companies formulated by the China Securities Regulatory Commission have tried to resolve the problem by strengthening the regulation of share issues, holding intermediaries responsible for their behaviour and promoting the listing of enterprises with excellent performance.

Now, let's have a look at the actual situation of the domestic stock market over the past couple of years. The Shanghai Stock Exchange index rocketed from 1,000 points to 1,700 a 70 percent rise. However, the performance of those listed companies, on which the growth of the domestic stock market depends, has not made any noticeable progress, though stock reforms have been carried out in the majority of these firms.

Listed firms generally registered a mediocre performance in the first quarter of this year, according to data about 1,340 listed companies.

Among the 1,340, 255 sustained losses, nearly 20 percent of the total, in contrast with 15.85 percent in the first quarter of last year.

By May 11, 315 companies listed on the Shanghai and Shenzhen stock exchanges had issued reports on their mid-term performance, revealing that 188 firms had suffered losses.

How could the rocketing of share prices in such a short period of time be explained against this backdrop? Could the answer be anything other than "artificial manipulation?"

In addition, research demonstrates that the 1,200 listed companies outside the top 200 listed firms suffered total losses of 7.5 billion yuan (US$937.5 million), with their total profits being included in the calculation.

Strangely, many of these listed companies, which should have long been eliminated from or marginalized on the stock market, enjoyed a very high return rate on the bourse. It is these companies, however, which have become the mainstay in propping up the upward trend of the domestic stock market. In other words, the rapid share price rise on domestic bourses is driven by speculation on junk shares rather than by the improved performance of the listed firms or by the improvement of the bourses' operational climate.

Although the securities regulatory authorities have stepped up their crackdown on speculative irregularities, problems such as behind-the-scenes manipulation and false accounting still exist.

For example, China CAMC Engineering Co Ltd was listed on June 19 at Shenzhen Stock Exchange. China CAMC shares were already 131 percent higher than their face value at the start of trading. The price rose 575.67 percent in the afternoon and closed at 31.97 yuan (US$4), enjoying a rise of 332.03 percent. However, China CAMC shares plummeted the very next day. All this indicates that speculative irregularities can never be avoided if the stock market infrastructure remains basically the same.

The domestic stock market suffered setbacks several weeks ago, affected by sliding international share prices. On June 7, for instance, panic selling occurred on the domestic bourses, mirrored by the Shanghai Stock Exchange's plummeting indices, which closed below 1,600 points on that day.

Some attributed this to the great shocks sent by international stock exchanges, while others said it was due to the bursting of stock bubbles. In the opinion of this author, however, it was rooted in the absence of an operational mechanism that facilitated the coming of a "bullish" market. Incessant speculative practices are the underlying cause of this.

For example, the prevalent idea on the domestic stock market some time ago was that rising stock indices demonstrated the necessity of "re-evaluating" the Chinese stock market. People of this opinion argued that the appreciation of the renminbi and foreign businesses rushing to buy renminbi-based property triggered the re-evaluation of land-property shares and commerce stocks. They also cited international commodity futures interacting with individual shares and H shares (shares of Chinese mainland firms listed in Hong Kong) pulling A-shares (shares for mainland investors only) along with them.

This author, in view of this body of opinion, once pointed out that basic changes would take place on the domestic economic landscape if the government's economic policies took a sharp turn in the opposite direction, which were necessitated by long-standing overheated investment and ever-growing land property bubbles. With these fragile and volatile conditions as the basis of a re-evaluation of the domestic stock market, another round of stock-share speculations is naturally on the horizon.

The plummeting domestic stock market several weeks ago sent severe warning signals to domestic investors: The stock market is confronted with uncertainty and great risks. Investors, therefore, should remain cautious, instead of being galvanized into action by mere hearsay or "optimistic news." Otherwise, they will be trapped.

Those manipulative institutional investors would pay a high price if they continue to blow up stock bubbles by creating "encouraging news" or staging investment stunts. This is because what they are doing does nothing to bring about an effective market mechanism. All these manipulative acts and stunts will, therefore, finally backfire on them.

It will not be easy to form a benign stock-market climate, improve corporate management and establish corporate credibility. If our hopes for a stock-market boom are pinned solely on a declaration of policy, a once-and-for-all institutional reform, or even on publicity stunts, nothing will change. The unreasonably sharp rise and fall of share prices vindicates this argument.

At the same time, changes in how management copes with the sharp fluctuations of the stock market are called for as a result of the dramatic changes that have taken place on the domestic bourses in 15 years since stock exchanges were first introduced in the country. It will be impossible for the stock market to develop on a healthy footing if management applies never-changing methods to the ever-changing situations.

Note: the author is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences.

(China Daily June 23, 2006)