Newsletter July 2006

Liquidity of the Chinese stock universe   Liquidity, or the ability to buy and sell large blocks without effecting the share price, is perhaps the most important factor for institutional investors in choosing where to execute their trades.  Looking at the Chinese stock universe from an American investor’s point of view, there are three markets that investors would consider: the NYSE, the NASDAQ and the Hong Kong Stock Exchange. Investing in Shanghai and Shenzen is still limited for foreigners and is further complicated by corporate accounting differences and information asymmetry. This Issue provides an analysis of market depth and  its impact on trading. As such, it offers useful measure of risk to investors in the Chinese markets. Drawing on twenty-four months of trading data for every stock in our analysis, we determined the impact on share prices of both a US$1 million stock purchase and sale.1  The results illustrate the wide difference in market depth and liquidity in global equity markets. As expected, liquid, large cap stocks appear to be resilient to the $1 million impact; however there are dramatic and somewhat surprising differences among the markets. As the follwing chart shows,  Hong Kong appears to be the most liquid market followed by the NYSE and the NASDAQ. There are only two stocks that are more liquid in the U.S. than in Hong Kong: PetroChina and Tom Online. Looking at the chart below, which measures the impact of significant stock purchases on stock price movement, HSBC Holdings on the Hong Kong Exchange (HKEx) tops the liquidity list, requiring almost US$600 million on the buy side to move the stock price higher by one percent. But, HSBC is unique. China Mobile (0941.HK) is a distant second, requiring slightly more than US$90 million to move its stock the same one percent higher. Rounding out the top five on the HKEx are China Life Insurance (2628.HK) and the oil triumvirate of Sinopec (0386.HK) CNOOC (0883.HK) and PetroChina (0857.HK). The list is somewhat different in New York. HSBC (HBC) is leading followed by PetroChina (PTR) very closely. Hong Kong’s favorite China Mobile (CHL) is overshadowed by both  Sinopec (SNP), China Life Insurance (LFC) and CNOOC (CEO). Looking at the NASDAQ listing, Baidu.com (BIDU), the Chinese search engine, is way above the average with  roughly US$40 million to move the stock price up one percent. Other liquid stocks include NetEase (NTES), Shanda (SNDA), Sina Corp. (SINA), Sohu.com (SOHU) and Tom Online (TOMO). Having looked at individual stocks in the three markets, let’s focus on the three markets in the aggregate and evaluate how much it takes to move average stock prices in each market. In summary, it takes approximately US$1 million on average to move a stock one percent in the NASDAQ, about three times this amount in the NYSE, and approximately 13 times this amount in Hong Kong. Given the strong price correlation between the Hong Kong and U.S. listings, it is fair to say that it takes 13 times more to move the NYSE listings versus the NASDAQ names. Actually, it is the Hong Kong market that sets the price for the Hong Kong-NYSE cross-listed stock and the NYSE listing typically follows the Hong Kong move. Remember, all our NYSE listings are cross-listed stocks, listed in the NYSE and Hong Kong simultaneously. It is not true for the NASDAQ names except for TOM Online (TOMO:NASDAQ and 8282.HK:HKEx). After looking at how much it takes to move a stock up one percent, let’s see what it takes to bring it down one percent. As the chart above suggests, the same trend holds true when a stock is under selling pressure. It takes a lot to move big, liquid names while small cap NASDAQ stocks are more sensitive and thus easer to manipulate. Interestingly, it takes only $31 million to bring BIDU down one percent vs. $43 million to lift it the same percent. The same gap, approximately $10 million dollars, occurs at China Mobile in Hong Kong (0941.HK) and China Telecom (0728.HK). The NYSE listings are very well balanced with no significant difference between buying and selling impact. Our interpretation of these finding is as follows: stocks that are more sensitive to selling pressure are considered riskier than those that are not. Again, we have identified Baidu.com (BIDU), China Mobile (0941.HK) and China Telecom (0728.HK)  as particularly dangerous when the market turns south. In addition to the impact of $1 million on share price, let’s look at the same measure from a different perspective: the number of shares needed to move the stock price one percent. Calculation the number of shares is merely an extension of the same data we have previously examined. Seemingly large discrepancies between these numbers and the USD normalized data is explained by the differences  in average USD share prices from market to market. As the following chart shows, it takes tens of millions of shares traded to move the stock price up or down one percent in Hong Kong, a significantly different circumstance than that found in the U.S. markets. Again, large differences of the markets are explained by the significant difference in share prices when normalized to USD. The chart gives us another look at how much it takes to move a stock up or down. Again, moving a stock down one percent takes less on average, highlighting the human nature of the stock markets: no one wants to be the last one holding a falling stock. This again underlines the existence of the  so-called herd behavior; “If you are selling, I don’t need to know why. I’m selling too.” Interestingly there are some stocks that show different characteristics; notably China Life Insurance (2628.HK). Looking at the chart, it takes over 65 million shares to short to move the stock price down 1%, while it takes only 46 million to move it up 1%. One possible explanation is that the stock has experienced a significant rally in the last  two years  (the stock is up 150% since July 2004) thus significantly increasing money flows into the stock. Also the increased money flow took place during the rally, eventually increasing the required amount to move the stock. So while the proportionate amount required  to move the stock price higher increased, the required amount to move it down did not change as much. But this theory is based on common sense and is also suggests that once the market  sours on LFC, it may need proportionately higher money outflow to move the stock down. Another stock that strikes the reader is China Telecom (0728.HK). It takes 83 million shares to buy to move the stock up 1% but only 55 million to sell to move it down 1%. And the stock price is virtually unchanged  by looking at the price history of the last two years. This may suggest that this stock is indeed considered risky because investors have significantly less confidence in the stock when market sentiment turns south. Our final chart gives us a chance to look at the less liquid stocks, their  money flow characteristics. The following chart shows how big impact USD 1 million has on the stock price. By looking at the absolute numbers there are seven stocks that will move at least 100% under one million dollar buying or selling pressure. They are Hurray Holding (HRAY), Ninetowns Digital World (NINE), eLong Inc. (LONG) and China Finance Online (JRJC) from the NASDAQ, followed by China Brilliance Auto (CBA) and Semiconductor Manufacturing international (SMI) from the NYSE and Tom Online (8282.HK) from Hong Kong. The best possible interpretation of these results is that these stocks are extremely sensitive to larger trades and thus are not recommended for institutional investors. The opposite is true for stocks that are virtually unaffected by a million dollar trade. They are NetEase (NTES) and Baidu.com (BIDU) from the NASDAQ, Sinopec (SNP), PetroChina (PTR), CNOOC (CEO), HSBC Holdings (HBC) and China Life Insurance (LFC) from the NYSE and again Sinopec (0386.HK), China Mobile (0941.HK), China Telecom (0728.HK), PetroCchina (0857.HK), CNOOC  Ltd. (0883.HK), Huaneng Power (0902.HK), HSBC Holdings (0005.HK) and China Life Insurance (2628.HK) from the Hong Kong Stock Exchange. These are the stocks that are recommended for institutional investors to invest in. Comparing the one million dollar impact on buying or selling, it is true again that the market is more sensitive to selling pressure; e.g. one million dollar selling pressure yields more price erosion than price appreciation of one million dollar buying. Looking at stocks, from the less liquid stock universe,  that have significantly different characteristics to buying or selling pressure are Hurray Holding (HRAY) and China Brilliance Auto (CBA). And finally, looking at the chart from an internationally diversified investor’s point of view, if you go and invest in Chinese companies, your best bet is doing so in Hong Kong where sufficient liquidity and the excellence of the HKEx will minimize your exposure to market characteristics.   To access latest Newsletter and other research content, please register!