China Shares Rally to 7-Year High but Investors May Want to Wait

TAIPEI, Taiwan (TheStreet) -- Shares on China's major exchange hit a seven-year year Friday after months of quick gains, but domestic pressures threaten to drag it down again and foreign investors should be cautious.

The Shanghai Composite Index, where the titans of China's 2,500 listed companies are traded, reached a volume of 5,050 early Friday but quickly gave more than 100 back. Chinese shares gained 47% over all of last year.

But a stock chart looks like the back of a stegosaurus, with sharp spikes and dips. Stocks posted a 6% drop one day in the final week of May and a 4.9% gain Monday.

China's shares are still emerging. Its central bank is weighing another round of restrictions on margin lending to ease volatility in a highly leveraged market. A pack of IPOs, including 23 set for June, is diverting some funds away from the broad market into those companies.

"I would stay out for the time being. I'm not someone who likes volatility. I trade long term," said Chester Liaw, economist at Forecast Pte in Singapore. "I'd watch out for more news from the central bank to see if they're going to introduce any new policies and whether they are going tighten margin lending."

Before the 2014-2015 rally, foreign investors worried because of the market's record of poor transparency, risks to minority shareholders and spotty regulations. Over the past year China's own citizens have invested heavily -- a prime reason for the surge -- to park their wealth as the historically preferred property market softens. Some of them are worried, too.

"Investor expectations are quite sensitive and they have different expectations," said Zhao Xijun, deputy finance school dean at Renmin University in Beijing. "The Shanghai exchange reaching 7,000 - there's that expectation but also those expecting volatility with falls."

Foreign funds, the only China access point for retail investors from overseas, expect gains.

A number of offshore asset managers have opened China funds over the past year. Scotland-based Aberdeen Asset Management (ABDNY), for example, opened a fund to invest in 25 companies it considers beacons of economic growth for the $10 trillion-plus economy.

Exchange traded funds are also growing. The Deutsche X-trackers Harvest CSI 300 China A-Shares Fund (ASHR) in April increased from one to five the number of creation units that it would accept per day. It competes with a list of other ETFs such as the fast-growing FTSE China Bull 3X Shares (YINN).

Foreign institutions with licenses to trade in Chinese shares are also pursuing higher quotas. In March Fidelity won an $800 million increase for a total $1.2 billion.

Initial public offerings may add to the optimism of some foreign funds. One to-be-listed firm, China National Nuclear Power, generated $273 billion in bids for its listing this month, above what it expected.

"IPOs are a good trend and a healthy trend," said Jack Perkowski, managing partner of merchant bank JPF Holdings in Beijing. "It's giving money to more private companies that are able to use it more effectively than state-owned enterprises."

This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.

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