Note: These are Roey Li's informal and unofficial translations, with full credit given to the original authors and texts linked below. I occasionally translate and share insightful reviews on contemporary Chinese economic and social issues.

Source: 青年志Youthology

Date: July 19, 2024

Original Mandarin: A股为什么不随经济增长而增长

Original Author: 李厚辰 （Houchen Li）

Cover Page: Reuters

TL;DR: In this article, Li explores the puzzling disconnect between China's economic growth and its stagnant stock market.

Despite China's rapid economic expansion and increased corporate profits, the A-share market remains sluggish. Reasons he discussed include:

1. Weighted Stocks' Impact: The concentration of state-owned enterprises (SOEs) in weighted stocks, which often face profitability challenges, drags down the overall index. Unlike tech-heavy indices in the U.S., China's market is dominated by banks and insurance companies.

2. Rapid Market Expansion: The fast-paced growth in the number of listed companies has spread available funds too thin, limiting stock price increases and market capitalization growth.

3. Delisting Dilemmas: Low delisting rates and the presence of many underperforming SOEs stifle market dynamism, leading to an imbalance between supply and demand.

4. Liquidity fund diversion: Despite a significant increase in China's broad money supply (M2), much of this liquidity has been absorbed by the real estate market and fixed asset investments rather than flowing into the stock market.

5. Liquidity Constraints: Restrictions on short selling and the absence of market makers limit market liquidity, reducing the incentive for investment and hindering price formation.

The article argues that these structural issues, rather than moral failings, are the root causes of the stock market's disconnect from China's economic growth. Addressing these non-market factors is crucial for aligning the stock market with the broader economy.

For a long time, the Chinese stock market has captivated millions of investors. Among the many "dramas" surrounding the stock market, the story of Hu Xijin, former editor-in-chief of Global Times, who began trading stocks in 2023, is quite representative. At the end of June, he reflected on his first anniversary of opening an account in the A-shares market on Weibo, revealing a total loss of 74,597 yuan, which is 10.65% of his principal investment of 700,000 yuan. In contrast to the A-shares, global stock markets have surged post-pandemic due to factors like inflation, with many markets reaching historical highs. Even if they haven't broken historical records, several emerging markets have experienced significant increases. Meanwhile, the A-shares have been fluctuating, with the index repeatedly returning to the 3,000-point defense line (closing at 2,977.13 points the day before this article was published).

Historically, after the boom and bust of 2007-2008 (with a peak of 6,124 and a low of 1,664), the A-shares have been in a long-term oscillation. By the end of December 2009, the index was at 3,068 points, not much different from the current level. It is often said that the stock market is a barometer of the economy. Regardless of its quality, the rapid development of China's economy over the past few decades is undeniable: surpassing Japan in 2010 to become the second-largest economy, overtaking the United States in 2020 to become the world's largest trading nation, and achieving a per capita GDP of over $10,000. While the overall economy and corporate profits have been growing, the stock market remains an exception.

A stagnant stock market affects everyone, not just stock investors. For instance, preserving the value of social security and pension funds is a critical issue for major countries worldwide. Without viable means to increase their value, facing an aging society becomes more challenging. The total assets of the world's top 300 pension funds amount to $23.6 trillion, with a significant portion invested in the stock market. North American pension funds have the highest proportion of their assets in stocks, at 45.6%. European and Asia-Pacific pension funds also have substantial stock market investments, accounting for 25.9% and 25.5% of their total assets, respectively.

Why is there such a significant disconnect between the Chinese stock market and the economic system? Today, we will explore this topic.

The A-share index we commonly discuss is the SSE Composite Index (full name: Shanghai Stock Exchange Composite Index). How is this index calculated? Suppose there are three companies in the market, A, B, and C, with market values of 2 billion, 3 billion, and 5 billion, respectively. If the number of companies remains unchanged, and Company A rises by 10%, Company B rises by 10%, and Company C falls by 15%, then according to simple weighted calculation, the overall stock index would fall by 2.5%.

Another common scenario is when, assuming the total number of investors remains unchanged, a new company D with a market value of 2 billion is listed in addition to ABC. Investors in ABC would inevitably sell some of their ABC shares to invest in D. According to market supply and demand, this would lead to a decline in the prices of ABC companies. If the new funds are insufficient to drive up the price of Company D, the overall stock index would fall, and it might even lead to a decline in Company D's stock price.

For a single company, the stock price is formed by the aggregation of individual stock transactions. A company's profitability and investor confidence will influence the overall index through the weighted prices of these companies, resulting in rises and falls.

The two most important factors to consider are: first, the supply of stocks in the market and the funds in the stock market. Like any commodity, if funds are abundant, prices rise; if funds are insufficient, prices fall. Second, the company's profitability. The most profitable way for stocks is annual dividends. If a company's net profit continues to grow, its dividend capacity increases, allowing the stock to have a higher price. This is called the price-to-earnings ratio (P/E ratio), the simplest being the static P/E ratio, which is the ratio of the stock price to the known recent publicly disclosed earnings per share. The higher this number, the more overvalued the stock price is; the lower this number, the more undervalued the price is.

Currently, the static P/E ratios of major stock markets worldwide are as follows: the United States 21.79, the United Kingdom 10.51, Germany 14.91, India 23.17, Japan 16.40, and China is 12.82.

Therefore, the inability of the stock index to rise can generally be attributed to two reasons: first, the insufficient profitability of the major weighted companies, which drags down the overall stock index; second, low market liquidity, with too many stocks and too little capital in the stock market. While the logic seems very simple, the detailed analysis is somewhat complex.

First, the rise and fall of weighted stocks have a significant impact on stock indices. Taking the U.S. S&P 500 and the Shanghai Composite Index as examples:

For the S&P 500, the top-weighted stocks are Apple, Microsoft, Amazon, Meta, Tesla, NVIDIA, and Google. These seven companies account for 27.5% of the total market capitalization. For the Shanghai Composite Index, the top-weighted stocks are Moutai, ICBC, China Merchants Bank, Agricultural Bank of China, PetroChina, Bank of China, and China Life Insurance. These companies account for 17.1% of the total market capitalization.

U.S. weighted stocks are more concentrated in market value and are predominantly high-tech companies with outstanding profitability and rapid growth. In contrast, Chinese weighted stocks are mostly banks and insurance companies, sectors that have faced difficulties during economic downturns, as we've discussed in previous articles.

Why haven't Chinese tech stocks like Alibaba, Tencent, Baidu, and DiDi listed in China? This relates to the value orientation of the A-share market. The A-share main board is relatively conservative, favoring companies with already substantial profits. It's particularly unfriendly to tech companies still in their growth phase and potentially still loss-making, which may not even meet listing requirements.

Consequently, it's evident that the blue-chip stocks in the A-share market do not provide strong support for index growth.

The rapid expansion of the stock market can indeed lead to a situation where available funds are spread too thinly across a growing number of companies, potentially resulting in insufficiently weighted stock indices. This issue is more severe than the insufficient profitability of major weighted companies.

From 2008 to 2024, the Nasdaq saw a slight increase in the number of listed companies, from over 3,200 to 3,700, a 1.1-fold increase. However, its market capitalization grew significantly, from $4.5 trillion in 2012 to $23 trillion in 2024, a 5.1-fold increase. In contrast, the A-share market in China expanded much more rapidly. From 2008 to 2022, the number of listed companies grew from 1,590 to over 5,000, a 3.1-fold increase. Meanwhile, the total market capitalization grew from 22.88 trillion RMB in 2012 to 82.63 trillion RMB in 2024, a 2.6-fold increase.

Statistics show that between 1997 and 2017, the market capitalization of the A-share market increased by 27.5% annually, but 26.5% of this growth came from the issuance of new stocks by listed companies, with only 1% from stock price increases. This explains why investors find it challenging to benefit from the market.

Among the more than 5,000 listed companies, over 3,300 are private enterprises, about 1,400 are state-owned, and 177 are foreign-controlled. Although state-owned enterprises account for only 28% of the market by number, they dominate in terms of assets, profits, and dividends, accounting for 78.6%, 69.3%, and 66.5% of the A-share market, respectively. As of December 31, 2023, the total market capitalization of state-owned enterprises was 42.15 trillion RMB, representing 51.65%, while private enterprises accounted for 31.68 trillion RMB, or 38.81%.

State-owned enterprises heavily influence the valuation and indices of the A-share market, but their growth and profitability are concerning. For instance, one-third of these are Local Government Financing Vehicle (LGFV), including various city parks, construction companies, real estate, and water groups, totaling 457 companies, many of which have been struggling. Many LGFVs might not meet listing thresholds but have circumvented stock issuance approval through reverse mergers. After the 2017 notice on regulating local government debt financing, many urban investment companies listed through mergers and acquisitions, typically with large asset sizes and high debt levels.

It is reasonable for enterprises of various ownership types to raise funds through listing, as the primary function of the stock market is to help companies finance. However, if the market expands too rapidly, especially with an abundance of asset-heavy, highly indebted companies with insufficient growth potential, the stock index will inevitably be dragged down. The fact that so many state-owned enterprises can be listed highlights the non-market factors at play, which may further complicate the issue of delisting.

For a long time, the proportion of delisted companies in the A-share market has remained in the single digits, which is naturally much lower compared to Nasdaq's annual delisting rate of around 5%. After 2019, the number of delisted companies in the A-share market increased, with 12, 20, 23, 50, and 43 companies delisted from 2019 to 2023, respectively. Even in the peak year, the delisting rate was only 1%.

Although China's stock market has delisting standards, such as financial delisting for companies with revenues below 100 million RMB and face value delisting for stocks trading below 1 RMB, companies still use various accounting methods to avoid delisting. For example, they might incur large losses in one year (by accounting for various costs upfront, reducing total costs in the second year) to improve revenue and profit figures in the following year.

Delisting, as the name suggests, requires a company to repurchase its circulating shares unless it goes bankrupt and liquidates after delisting, which is almost the opposite of raising capital through listing. Therefore, the cost of delisting is either bankruptcy or a significant amount of money for repurchase. Both of these outcomes are very difficult for state-owned enterprises (SOEs), and non-market factors further complicate the actual delisting of SOEs. The stock market's inability to renew itself over the long term leads to an imbalance between supply and demand, resulting in liquidity being lower than the total circulating stock, making it inevitable that prices cannot rise.

Thus, delisting is not just a matter of having rules, but also whether the enforcing body is independent and can strictly enforce those rules.

In fact, even if the stock market expands rapidly, if the inflow of funds also grows significantly, the total market capitalization can grow quickly. Over the past few years, China's broad money supply (M2)—which, in addition to M1 (current deposits of enterprises), includes bank deposits of corporate time deposits, money market funds, and insurance funds—has grown at an astonishing rate. The balance surged from 97 trillion RMB at the end of 2012 to 300 trillion RMB now. During this period, the total market capitalization of the A-shares grew proportionally with M2, accounting for 23% of the M2 balance in 2012 and 25% in 2023. However, while the market capitalization grew, the index remained unchanged, indicating that the new funds were almost entirely absorbed by the market expansion.

Moreover, we need to examine whether this ratio is reasonable. Comparing the total market capitalization of U.S. stocks with the U.S. M2 balance, this value rose from 150% to 204% from 2012 to 2023. You read that right—the total market capitalization is larger than the M2 total, not smaller. Market capitalization is a non-circulating concept, similar to how a company's market value is generally greater than its cash flow. Likewise, a country's total assets will certainly be greater than its M2 monetary balance. From this perspective, China's stock market funds are actually severely insufficient.

It is evident that in recent years, a large portion of M2 growth has not entered the stock market but has gone into the real estate market and fixed asset investments like infrastructure. Since 2016, China's annual real estate sales have exceeded 10 trillion RMB, reaching as high as 15 trillion RMB at the peak. The amount going into infrastructure is even larger.

Here we can understand a certain flow direction of money: new M2 entering the real estate market could potentially enter the stock market. For example, if many people take loans to buy properties from Company A, this results in a substantial cash flow surplus and profit for Company A, which might then use this surplus and profit for stock market investments. This means that any cash flow surplus and profit from individuals and companies could potentially enter the stock market for appreciation. Even if a company borrows to pay employee salaries, employees could use this money to invest in the stock market. Unless M2 growth fails to bring about cash surpluses and profits—commonly referred to as the negative scissors difference between M1 and M2 (M1-M2)—this flow is possible.

The M1-M2 difference is often used to observe changes in Chinese consumer spending and corporate income. When people actively consume, funds from savings deposits flow into corporate current deposits, resulting in M1 growth outpacing M2, forming a positive scissors difference; conversely, when people are hesitant to consume or invest, M2 growth becomes larger, forming a negative scissors difference.

Over the past decade, a large portion of household cash surpluses has flowed into the real estate market, creating debt. Imagine someone with a 30-year mortgage; no wonder yhey have little money left for stock market investments. The situation on the corporate side is similar. The leverage ratio has increased not only among individuals but also among companies.

High leverage means high funding costs, and combined with the stagnation of stock indices amid rapid market expansion, this greatly limits the ability of funds to enter the stock market. Therefore, many companies, before 2021, also invested their funds in the more predictable real estate market. This creates a compounded downward spiral: the more sluggish the stock market, the lower the expected return, and the less likely it is for funds to enter the stock market. This further decreases stock market liquidity, restricting market capitalization growth.

In reality, the stock market is not a place where profits can only be made during periods of rising prices. The fundamental function of the capital market is to enable companies to achieve a fair price. This price can go up (going long) or down (going short). Many well-known funds have made money by short selling.

Investors can profit from the trading flow of stocks, not necessarily from their rise in value. A more freely flowing, unrestricted environment is more likely to achieve high liquidity. This includes real-time trading systems, options to go long or short, and even the use of high-frequency trading. Although these measures may increase short-term speculative behavior and volatility, they are beneficial for increasing market liquidity in the long run.

Short selling is often depicted as a "bad thing," as if it causes everyone to lose money, but this is not the case. We know that the increase in total market capitalization is closely related to the total profits of listed companies. Therefore, a healthy stock market needs to guide funds toward companies that are more worthy of investment and have better profit potential. How do we assess a company's value? It is essentially through their stock price. Stocks with strong profitability have higher prices, while those with lower profit potential have lower prices. Thus, there are two types of short-term mismatches in the stock market: one is that companies with strong profitability are undervalued, leading to insufficient funds and low prices; the other is that companies with poor profitability are overly hyped, leading to excessively high prices. At any time, the market needs to achieve the "should-be" price of a company to release the most reasonable price signal. Going long achieves the former, and going short achieves the latter. For the stock market as a "resource allocation mechanism," going long and short are symmetrical operations, with no inherent good or bad.

In China, short selling has long been restricted, with the belief that the short selling mechanism is one of the culprits of market downturns. Only institutional investors can short sell through the margin trading mechanism, and restrictions have been increasing since this year. This has led to a 70% reduction in the stock lending balance in the A-share market since the beginning of the year. On July 11 this year, the stock lending business was completely suspended, and the margin ratio for short selling was increased, further limiting short selling methods and raising the threshold for short selling. In the short term, this can certainly reduce market volatility, but if there are still bubbles in the market that need to be deflated, it merely reduces the "stock price," leading to medium- and long-term resource misallocation.

In addition to these trading systems, there are other systems related to price formation and liquidity, such as the market maker system. On the NYSE, each stock has a designated market maker responsible for providing liquidity in the absence of buy and sell orders, ensuring smooth market operation and helping to form stock prices. Nasdaq uses a multiple market maker system, where multiple market makers compete to quote the same stock.

The A-share main board does not have market makers; only the SME board has this mechanism. This is because, for a long time, market makers have been accused of excessive speculation, insider trading, and market manipulation. While these concerns are valid, in the absence of sufficient marketization and regulation, market makers can become pure arbitrage tools. However, without market makers, small and medium-sized stocks can face liquidity issues, leading to many stocks lacking trades and thus not forming prices.

All restrictions on liquidity will lead to a decrease in the motivation to invest funds in the market. Since 2023, liquidity in China's stock market has shrunk, and even with the national team stepping in, daily trading volume has dropped to around 600 billion RMB.

The persistent disconnect between the stock market and the economy has often been attributed to "moral issues," such as excessive share reduction by major shareholders, speculative behavior, and malicious short selling. Consequently, exchanges and regulators have primarily focused on restrictive measures—limiting share reductions, program trading, end-of-day trading, the scale of short selling, and implementing T+1 for securities lending. It is as if the removal of speculators would naturally lead to a rising stock market.

However, as our analysis suggests, these measures do not address issues such as the rapid non-market-driven expansion or the inability of companies to delist. The market's preference for large state-owned enterprises (SOEs) also fails to attract fast-growing internet companies. Increasing restrictions may temporarily prevent the stock market from falling too quickly, but in the long term, they limit the market's growth potential by reducing liquidity.

In modern society, whether for governments, enterprises, or individuals, there is a universal desire for wealth appreciation. The stock market is fundamentally a platform for sharing corporate development through equity structures. Under normal circumstances, the overall economy and corporate growth should be reflected in the stock market. Even in Pakistan, the stock market generally correlates positively with GDP growth. This disconnection is unlikely to be a moral issue; rather, it stems from non-market factors — the stock market does not reflect the true value of enterprises.

China's stock market has a relatively low price-to-earnings (P/E) ratio compared to global standards, which could indicate growth potential. However, the more pressing question, which this article seeks to address, is why an economy with such rapid past growth and historically high M2 growth rates has such a low stock market P/E ratio. Under what conditions can the stock market synchronize with economic growth?

Note: These are Roey Li's informal and unofficial translations, with full credit given to the original authors and texts linked below. I occasionally translate and share insightful reviews on contemporary Chinese economic and social issues.

Source: 青年志Youthology

Date: July 19, 2024

Original Mandarin: A股为什么不随经济增长而增长

Original Author: 李厚辰 （Houchen Li）

Cover Page: Reuters

TL;DR: In this article, Li explores the puzzling disconnect between China's economic growth and its stagnant stock market.

Despite China's rapid economic expansion and increased corporate profits, the A-share market remains sluggish. Reasons he discussed include:

1. Weighted Stocks' Impact: The concentration of state-owned enterprises (SOEs) in weighted stocks, which often face profitability challenges, drags down the overall index. Unlike tech-heavy indices in the U.S., China's market is dominated by banks and insurance companies.

2. Rapid Market Expansion: The fast-paced growth in the number of listed companies has spread available funds too thin, limiting stock price increases and market capitalization growth.

3. Delisting Dilemmas: Low delisting rates and the presence of many underperforming SOEs stifle market dynamism, leading to an imbalance between supply and demand.

4. Liquidity fund diversion: Despite a significant increase in China's broad money supply (M2), much of this liquidity has been absorbed by the real estate market and fixed asset investments rather than flowing into the stock market.

5. Liquidity Constraints: Restrictions on short selling and the absence of market makers limit market liquidity, reducing the incentive for investment and hindering price formation.

The article argues that these structural issues, rather than moral failings, are the root causes of the stock market's disconnect from China's economic growth. Addressing these non-market factors is crucial for aligning the stock market with the broader economy.

For a long time, the Chinese stock market has captivated millions of investors. Among the many "dramas" surrounding the stock market, the story of Hu Xijin, former editor-in-chief of Global Times, who began trading stocks in 2023, is quite representative. At the end of June, he reflected on his first anniversary of opening an account in the A-shares market on Weibo, revealing a total loss of 74,597 yuan, which is 10.65% of his principal investment of 700,000 yuan. In contrast to the A-shares, global stock markets have surged post-pandemic due to factors like inflation, with many markets reaching historical highs. Even if they haven't broken historical records, several emerging markets have experienced significant increases. Meanwhile, the A-shares have been fluctuating, with the index repeatedly returning to the 3,000-point defense line (closing at 2,977.13 points the day before this article was published).

Historically, after the boom and bust of 2007-2008 (with a peak of 6,124 and a low of 1,664), the A-shares have been in a long-term oscillation. By the end of December 2009, the index was at 3,068 points, not much different from the current level. It is often said that the stock market is a barometer of the economy. Regardless of its quality, the rapid development of China's economy over the past few decades is undeniable: surpassing Japan in 2010 to become the second-largest economy, overtaking the United States in 2020 to become the world's largest trading nation, and achieving a per capita GDP of over $10,000. While the overall economy and corporate profits have been growing, the stock market remains an exception.

A stagnant stock market affects everyone, not just stock investors. For instance, preserving the value of social security and pension funds is a critical issue for major countries worldwide. Without viable means to increase their value, facing an aging society becomes more challenging. The total assets of the world's top 300 pension funds amount to $23.6 trillion, with a significant portion invested in the stock market. North American pension funds have the highest proportion of their assets in stocks, at 45.6%. European and Asia-Pacific pension funds also have substantial stock market investments, accounting for 25.9% and 25.5% of their total assets, respectively.

Why is there such a significant disconnect between the Chinese stock market and the economic system? Today, we will explore this topic.

The A-share index we commonly discuss is the SSE Composite Index (full name: Shanghai Stock Exchange Composite Index). How is this index calculated? Suppose there are three companies in the market, A, B, and C, with market values of 2 billion, 3 billion, and 5 billion, respectively. If the number of companies remains unchanged, and Company A rises by 10%, Company B rises by 10%, and Company C falls by 15%, then according to simple weighted calculation, the overall stock index would fall by 2.5%.

Another common scenario is when, assuming the total number of investors remains unchanged, a new company D with a market value of 2 billion is listed in addition to ABC. Investors in ABC would inevitably sell some of their ABC shares to invest in D. According to market supply and demand, this would lead to a decline in the prices of ABC companies. If the new funds are insufficient to drive up the price of Company D, the overall stock index would fall, and it might even lead to a decline in Company D's stock price.

For a single company, the stock price is formed by the aggregation of individual stock transactions. A company's profitability and investor confidence will influence the overall index through the weighted prices of these companies, resulting in rises and falls.

The two most important factors to consider are: first, the supply of stocks in the market and the funds in the stock market. Like any commodity, if funds are abundant, prices rise; if funds are insufficient, prices fall. Second, the company's profitability. The most profitable way for stocks is annual dividends. If a company's net profit continues to grow, its dividend capacity increases, allowing the stock to have a higher price. This is called the price-to-earnings ratio (P/E ratio), the simplest being the static P/E ratio, which is the ratio of the stock price to the known recent publicly disclosed earnings per share. The higher this number, the more overvalued the stock price is; the lower this number, the more undervalued the price is.

Currently, the static P/E ratios of major stock markets worldwide are as follows: the United States 21.79, the United Kingdom 10.51, Germany 14.91, India 23.17, Japan 16.40, and China is 12.82.

Therefore, the inability of the stock index to rise can generally be attributed to two reasons: first, the insufficient profitability of the major weighted companies, which drags down the overall stock index; second, low market liquidity, with too many stocks and too little capital in the stock market. While the logic seems very simple, the detailed analysis is somewhat complex.

First, the rise and fall of weighted stocks have a significant impact on stock indices. Taking the U.S. S&P 500 and the Shanghai Composite Index as examples:

For the S&P 500, the top-weighted stocks are Apple, Microsoft, Amazon, Meta, Tesla, NVIDIA, and Google. These seven companies account for 27.5% of the total market capitalization. For the Shanghai Composite Index, the top-weighted stocks are Moutai, ICBC, China Merchants Bank, Agricultural Bank of China, PetroChina, Bank of China, and China Life Insurance. These companies account for 17.1% of the total market capitalization.

U.S. weighted stocks are more concentrated in market value and are predominantly high-tech companies with outstanding profitability and rapid growth. In contrast, Chinese weighted stocks are mostly banks and insurance companies, sectors that have faced difficulties during economic downturns, as we've discussed in previous articles.

Why haven't Chinese tech stocks like Alibaba, Tencent, Baidu, and DiDi listed in China? This relates to the value orientation of the A-share market. The A-share main board is relatively conservative, favoring companies with already substantial profits. It's particularly unfriendly to tech companies still in their growth phase and potentially still loss-making, which may not even meet listing requirements.

Consequently, it's evident that the blue-chip stocks in the A-share market do not provide strong support for index growth.

The rapid expansion of the stock market can indeed lead to a situation where available funds are spread too thinly across a growing number of companies, potentially resulting in insufficiently weighted stock indices. This issue is more severe than the insufficient profitability of major weighted companies.

From 2008 to 2024, the Nasdaq saw a slight increase in the number of listed companies, from over 3,200 to 3,700, a 1.1-fold increase. However, its market capitalization grew significantly, from $4.5 trillion in 2012 to $23 trillion in 2024, a 5.1-fold increase. In contrast, the A-share market in China expanded much more rapidly. From 2008 to 2022, the number of listed companies grew from 1,590 to over 5,000, a 3.1-fold increase. Meanwhile, the total market capitalization grew from 22.88 trillion RMB in 2012 to 82.63 trillion RMB in 2024, a 2.6-fold increase.

Statistics show that between 1997 and 2017, the market capitalization of the A-share market increased by 27.5% annually, but 26.5% of this growth came from the issuance of new stocks by listed companies, with only 1% from stock price increases. This explains why investors find it challenging to benefit from the market.

Among the more than 5,000 listed companies, over 3,300 are private enterprises, about 1,400 are state-owned, and 177 are foreign-controlled. Although state-owned enterprises account for only 28% of the market by number, they dominate in terms of assets, profits, and dividends, accounting for 78.6%, 69.3%, and 66.5% of the A-share market, respectively. As of December 31, 2023, the total market capitalization of state-owned enterprises was 42.15 trillion RMB, representing 51.65%, while private enterprises accounted for 31.68 trillion RMB, or 38.81%.

State-owned enterprises heavily influence the valuation and indices of the A-share market, but their growth and profitability are concerning. For instance, one-third of these are Local Government Financing Vehicle (LGFV), including various city parks, construction companies, real estate, and water groups, totaling 457 companies, many of which have been struggling. Many LGFVs might not meet listing thresholds but have circumvented stock issuance approval through reverse mergers. After the 2017 notice on regulating local government debt financing, many urban investment companies listed through mergers and acquisitions, typically with large asset sizes and high debt levels.

It is reasonable for enterprises of various ownership types to raise funds through listing, as the primary function of the stock market is to help companies finance. However, if the market expands too rapidly, especially with an abundance of asset-heavy, highly indebted companies with insufficient growth potential, the stock index will inevitably be dragged down. The fact that so many state-owned enterprises can be listed highlights the non-market factors at play, which may further complicate the issue of delisting.

For a long time, the proportion of delisted companies in the A-share market has remained in the single digits, which is naturally much lower compared to Nasdaq's annual delisting rate of around 5%. After 2019, the number of delisted companies in the A-share market increased, with 12, 20, 23, 50, and 43 companies delisted from 2019 to 2023, respectively. Even in the peak year, the delisting rate was only 1%.

Although China's stock market has delisting standards, such as financial delisting for companies with revenues below 100 million RMB and face value delisting for stocks trading below 1 RMB, companies still use various accounting methods to avoid delisting. For example, they might incur large losses in one year (by accounting for various costs upfront, reducing total costs in the second year) to improve revenue and profit figures in the following year.

Delisting, as the name suggests, requires a company to repurchase its circulating shares unless it goes bankrupt and liquidates after delisting, which is almost the opposite of raising capital through listing. Therefore, the cost of delisting is either bankruptcy or a significant amount of money for repurchase. Both of these outcomes are very difficult for state-owned enterprises (SOEs), and non-market factors further complicate the actual delisting of SOEs. The stock market's inability to renew itself over the long term leads to an imbalance between supply and demand, resulting in liquidity being lower than the total circulating stock, making it inevitable that prices cannot rise.

Thus, delisting is not just a matter of having rules, but also whether the enforcing body is independent and can strictly enforce those rules.

In fact, even if the stock market expands rapidly, if the inflow of funds also grows significantly, the total market capitalization can grow quickly. Over the past few years, China's broad money supply (M2)—which, in addition to M1 (current deposits of enterprises), includes bank deposits of corporate time deposits, money market funds, and insurance funds—has grown at an astonishing rate. The balance surged from 97 trillion RMB at the end of 2012 to 300 trillion RMB now. During this period, the total market capitalization of the A-shares grew proportionally with M2, accounting for 23% of the M2 balance in 2012 and 25% in 2023. However, while the market capitalization grew, the index remained unchanged, indicating that the new funds were almost entirely absorbed by the market expansion.

Moreover, we need to examine whether this ratio is reasonable. Comparing the total market capitalization of U.S. stocks with the U.S. M2 balance, this value rose from 150% to 204% from 2012 to 2023. You read that right—the total market capitalization is larger than the M2 total, not smaller. Market capitalization is a non-circulating concept, similar to how a company's market value is generally greater than its cash flow. Likewise, a country's total assets will certainly be greater than its M2 monetary balance. From this perspective, China's stock market funds are actually severely insufficient.

It is evident that in recent years, a large portion of M2 growth has not entered the stock market but has gone into the real estate market and fixed asset investments like infrastructure. Since 2016, China's annual real estate sales have exceeded 10 trillion RMB, reaching as high as 15 trillion RMB at the peak. The amount going into infrastructure is even larger.

Here we can understand a certain flow direction of money: new M2 entering the real estate market could potentially enter the stock market. For example, if many people take loans to buy properties from Company A, this results in a substantial cash flow surplus and profit for Company A, which might then use this surplus and profit for stock market investments. This means that any cash flow surplus and profit from individuals and companies could potentially enter the stock market for appreciation. Even if a company borrows to pay employee salaries, employees could use this money to invest in the stock market. Unless M2 growth fails to bring about cash surpluses and profits—commonly referred to as the negative scissors difference between M1 and M2 (M1-M2)—this flow is possible.

The M1-M2 difference is often used to observe changes in Chinese consumer spending and corporate income. When people actively consume, funds from savings deposits flow into corporate current deposits, resulting in M1 growth outpacing M2, forming a positive scissors difference; conversely, when people are hesitant to consume or invest, M2 growth becomes larger, forming a negative scissors difference.

Over the past decade, a large portion of household cash surpluses has flowed into the real estate market, creating debt. Imagine someone with a 30-year mortgage; no wonder yhey have little money left for stock market investments. The situation on the corporate side is similar. The leverage ratio has increased not only among individuals but also among companies.

High leverage means high funding costs, and combined with the stagnation of stock indices amid rapid market expansion, this greatly limits the ability of funds to enter the stock market. Therefore, many companies, before 2021, also invested their funds in the more predictable real estate market. This creates a compounded downward spiral: the more sluggish the stock market, the lower the expected return, and the less likely it is for funds to enter the stock market. This further decreases stock market liquidity, restricting market capitalization growth.

In reality, the stock market is not a place where profits can only be made during periods of rising prices. The fundamental function of the capital market is to enable companies to achieve a fair price. This price can go up (going long) or down (going short). Many well-known funds have made money by short selling.

Investors can profit from the trading flow of stocks, not necessarily from their rise in value. A more freely flowing, unrestricted environment is more likely to achieve high liquidity. This includes real-time trading systems, options to go long or short, and even the use of high-frequency trading. Although these measures may increase short-term speculative behavior and volatility, they are beneficial for increasing market liquidity in the long run.

Short selling is often depicted as a "bad thing," as if it causes everyone to lose money, but this is not the case. We know that the increase in total market capitalization is closely related to the total profits of listed companies. Therefore, a healthy stock market needs to guide funds toward companies that are more worthy of investment and have better profit potential. How do we assess a company's value? It is essentially through their stock price. Stocks with strong profitability have higher prices, while those with lower profit potential have lower prices. Thus, there are two types of short-term mismatches in the stock market: one is that companies with strong profitability are undervalued, leading to insufficient funds and low prices; the other is that companies with poor profitability are overly hyped, leading to excessively high prices. At any time, the market needs to achieve the "should-be" price of a company to release the most reasonable price signal. Going long achieves the former, and going short achieves the latter. For the stock market as a "resource allocation mechanism," going long and short are symmetrical operations, with no inherent good or bad.

In China, short selling has long been restricted, with the belief that the short selling mechanism is one of the culprits of market downturns. Only institutional investors can short sell through the margin trading mechanism, and restrictions have been increasing since this year. This has led to a 70% reduction in the stock lending balance in the A-share market since the beginning of the year. On July 11 this year, the stock lending business was completely suspended, and the margin ratio for short selling was increased, further limiting short selling methods and raising the threshold for short selling. In the short term, this can certainly reduce market volatility, but if there are still bubbles in the market that need to be deflated, it merely reduces the "stock price," leading to medium- and long-term resource misallocation.

In addition to these trading systems, there are other systems related to price formation and liquidity, such as the market maker system. On the NYSE, each stock has a designated market maker responsible for providing liquidity in the absence of buy and sell orders, ensuring smooth market operation and helping to form stock prices. Nasdaq uses a multiple market maker system, where multiple market makers compete to quote the same stock.

The A-share main board does not have market makers; only the SME board has this mechanism. This is because, for a long time, market makers have been accused of excessive speculation, insider trading, and market manipulation. While these concerns are valid, in the absence of sufficient marketization and regulation, market makers can become pure arbitrage tools. However, without market makers, small and medium-sized stocks can face liquidity issues, leading to many stocks lacking trades and thus not forming prices.

All restrictions on liquidity will lead to a decrease in the motivation to invest funds in the market. Since 2023, liquidity in China's stock market has shrunk, and even with the national team stepping in, daily trading volume has dropped to around 600 billion RMB.

The persistent disconnect between the stock market and the economy has often been attributed to "moral issues," such as excessive share reduction by major shareholders, speculative behavior, and malicious short selling. Consequently, exchanges and regulators have primarily focused on restrictive measures—limiting share reductions, program trading, end-of-day trading, the scale of short selling, and implementing T+1 for securities lending. It is as if the removal of speculators would naturally lead to a rising stock market.

However, as our analysis suggests, these measures do not address issues such as the rapid non-market-driven expansion or the inability of companies to delist. The market's preference for large state-owned enterprises (SOEs) also fails to attract fast-growing internet companies. Increasing restrictions may temporarily prevent the stock market from falling too quickly, but in the long term, they limit the market's growth potential by reducing liquidity.

In modern society, whether for governments, enterprises, or individuals, there is a universal desire for wealth appreciation. The stock market is fundamentally a platform for sharing corporate development through equity structures. Under normal circumstances, the overall economy and corporate growth should be reflected in the stock market. Even in Pakistan, the stock market generally correlates positively with GDP growth. This disconnection is unlikely to be a moral issue; rather, it stems from non-market factors — the stock market does not reflect the true value of enterprises.

China's stock market has a relatively low price-to-earnings (P/E) ratio compared to global standards, which could indicate growth potential. However, the more pressing question, which this article seeks to address, is why an economy with such rapid past growth and historically high M2 growth rates has such a low stock market P/E ratio. Under what conditions can the stock market synchronize with economic growth?