China's Fine, but Beware the Stocks

So what else did anyone expect?

The Shanghai stock market blew up today, dropping almost 9%. That was the biggest drop in the Shanghai index in a decade, and it wiped out more than $100 billion in stock market capitalization.

No one should be surprised. And no one should think this has anything to do with a slowdown in China's economy.

The Shanghai market was a stock speculator's wildest dream come true, with that speculator's worst nightmare waiting in the wings. The game was fixed, and everybody knew it. While it lasted, the profits were too good to pass up -- the Shanghai index was up 170% since mid-2005. Every investor hoped to be first out the door when the day of reckoning came -- exactly the kind of rush to the exits that took place on Tuesday.

Tale of Two Markets

Notice I say the Shanghai market and not the Chinese stock market. Not all of China's stock markets panicked. On the same day that the Shanghai Composite Index fell 9%, Hong Kong's blue-chip Hang Seng Stock Index lost just 1.8%.

This isn't a one-time differential, either. On Jan. 12, the Shanghai index fell almost 4% while the Hang Seng actually climbed by more than 1%.

Think the difference might have something to do with the peculiar nature of the Shanghai (and the smaller Shenzhen) stock markets? The Shanghai stock market is essentially a domestic market for the A shares of China's publicly traded companies: Overseas investors are by and large not allowed to buy and sell A shares (although the rules have been relaxed a bit lately).

Who makes up this domestic stock market?