A Tale of Two Chinas

NEW YORK ( TheStreet) -- Casual observers of Chinese stock markets tend to, naturally, focus on the widely referenced broad indices, the Shanghai Composite and the Shenzhen Composite.

And the picture is not pretty. They have been on a steady decline since early May and still show little sign of rebounding. Ironically, the Chinese media and webosphere also tend to narrowly focus on the broad indices, adding to an ever-increasingly gloomy sense of doom.

But if one looks beyond the broad indices, a very different picture emerges. The blue chips, roughly represented by the Shanghai 50 Index, have shown remarkable resilience in the last three months (see chart below).

Some sectors, such as real estate and banking, have performed well. The real culprits of decline are generally the small-caps, liquor and food.

Chart 1: Three-month performance of FXI, Shanghai Composite and Shanghai 50 Indices

A number of things are happening here.

1. The stock market has been used as the easy way for founders and early investors to cash out. Absolutely nothing wrong on this aspect, if not for the fact that it's been plagued by various scams, such as faking data and senior management setting up their own private entities to siphon money from their public companies.

Such scams have reached hysterical levels since 2009, fueled by easy money from panic stimulus and the ultra-easy policy of China Securities Regulatory Committee, the Chinese equivalent of the SEC except being an even more incompetent joke of a regulator.

These junk stocks are gradually being outed in the market. This is very healthy self-correction and cleansing, as domestic investors gradually wake up from the delusion of blind profit due to absurdly high correlation in the perpetual bull market of yesteryears.

I expect a wave of delisting over the course of next few years. Good riddance.

2. The economic slowdown and bear market of the past seven months have shown many healthy effects of exposing the ugly and the evil. A big part of the ugly and evil is the dismal safety record of the food industry. They have been slaughtered, as long deserved.

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