Why You Won't Be Afraid to Invest in Chinese Stocks in Five Years

Editor's pick: This piece was originally published March 4.

TAIPEI, Taiwan (TheStreet) - Check the cynic's dictionary definition of volatility now and it says "Chinese stocks." That may someday need updating.

Forecasting stocks is as iffy as predicting earthquakes, so the usual who-really-knows caveats apply here. But people who follow the market expect that in about five years, Chinese share prices will start trading in a narrower range with a long-term upward trend almost like a Western stock exchange.

Shares fell 40% in mid-2015 on the benchmark Shanghai Composite Index after rising 150% over the previous year. They firmed from August through the end of the year but had sunk another 14% by March 3.

China's policymakers are aiming to bring market rules closer to international norms and lure more capital into stocks from fearful foreign investors or reticent Chinese individuals who now stash their wealth elsewhere. They see the stock market as a way to capitalize private enterprise and turn it into a new economic engine.

China will "modernize its financial market system in the next five years," state-run Xinhua News Agency pledged in November.

It's already starting to happen, and Chinese officials always achieve some semblance of whatever they set out to do, be that handling the SARS respiratory virus in 2003, cutting poverty to 10% in 2010 or keeping economic growth near 7% through last year. 

"Market regulations will progress and transition into something similar to their global counterparts," said Nitin Dialdas, chief investment officer with Hong Kong-based fund manager Mandarin Capital. "The likelihood is that the markets will need to open up, which will require the regulations to be in line with those that global investors are familiar with."

Stability for China's "A" shares, which cover more than 2,000 companies, would boost global institutions with government-issued investment quotas. Foreign individuals cannot invest in "A" shares but can buy into funds that do.

They might join, for example, the iShares China Large-Cap ETF (FXI) , the Goldman Sachs China Equity Fund Class "A" Shares (GNIAX) or the Fidelity Emerging Asia Fund (FSEAX) .

Here's a schematic laid out by China watchers who expect a smoother stock market within the next five years.

Chinese authorities will keep cracking down on insider trading and other white-collar crime. They may also continue liberalizing the yuan currency so it's more accessible offshore. Expect more state money in the markets and trial runs of new trading rules until they find a package that works. Authorities for example tried a circuit-breaker in January to halt trading when prices fall too far.

No one says any of that will be easy. The circuit breaker was called off in January and a ban on mass sell-offs was extended. The currency also keeps depreciating, discouraging foreign funds. The government itself, though used to a controlled economy, may eventually back away.

"The current leadership seems so comfortable with deep intervention in the stock market that it would be revolutionary for them to shift their approach to one of ensuring fairness and transparency," said Scott Kennedy, director with the Project on Chinese Business & Political Economy under U.S.-based think tank Center for Strategic & International Studies.

To help private money take over, the central bank cut interest rates six times over the 15 months to January and made it tougher to speculate on property. Officials want citizens to invest a cumulative $21 trillion now in bank deposits, twice the amount in the United States, in the stock market.

And to impress foreign institutions, China is relaxing rules on investment quotas and considering new schemes that would let foreigners trade "A" shares through unrestricted offshore markets. Today 568 such shares can be freely traded in Hong Kong.

Chinese authorities are taking these steps "to move capital into its stock markets, where it can be accessed by a wider range of companies to grow their businesses," said Jack Perkowski, managing partner of Beijing-based merchant bank JFP Holdings.

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

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