Shanghai Composite Stuck Around 3000

In 2007, the Shanghai Composite Index, also known as the SHCOMP, made headlines as it broke through the significant threshold of 3000 points and soared to an astonishing peak of 6124 pointsThis remarkable surge marked a moment of hope and optimism for investors and market fans alikeFast forward to 2023, and the scene has dramatically changedThe SHCOMP now lingers around the 3000-point mark, far from its historical zenith, leaving many to ponder the reasons behind this stagnation.

As the years have rolled on, opinions have varied regarding the apparent difficulties of the SHCOMP to stage a significant recoveryA commonly cited factor is the current structure of the Chinese stock market, characterized by practices that some perceive as detrimental to investorsLarge shareholders are accused of cashing out post-IPO, engaging in activities known as 'share selling', while institutional investors are accused of engaging in short-selling, thus perpetuating a cycle where retail investors are often left abandoned, left to suffer the consequences of their investments

Yet one must consider that the SHCOMP could have intrinsic issues contributing to its current predicament, specifically regarding its accuracy and representation of the broader market.

The concept of index distortion is crucial to understanding the challenges faced by the Shanghai CompositeThe SHCOMP is the first index established in the A-share market and has since become a central reference point for investorsHowever, it is essential to recognize the implications of adding new stocks to its constructionThe methodology behind the SHCOMP involves calculating its value based on total market capitalization—a process that has profound effects on its accuracy.

Over the years, the process by which new shares are added to the SHCOMP has had significant implicationsIn its earlier iterations, shares of newly listed companies often entered the index as soon as the day after their debut

• Insurers Bet on High Dividends Through 2025
• The Dollar and U.S. Bonds: America's Achilles' Heel
• Dollar Rises, Euro Falls
• Federal Reserve Rate Cut Remains in Question!
• Bond Yields Hover at a Decade High

Since new stocks typically opened at high valuations—with few exceptions hitting below their issue price—their inclusion tended to inflate the index artificiallyThis practice led to instances where the index appeared significantly higher than warranted, creating a misleading impression of market performance.

In more recent years, measures have been put in place to address this phenomenon, including postponing the entry of newly listed shares into the index until a year after their initial offeringWhile this adjustment has prevented the SHCOMP from being skewed too unfavorably, it has led to the opposite effect—slowly dragging down the index insteadA case in point occurred at the end of 2020, where the SHCOMP closed at 3473 points with a corresponding total market capitalization of 486.25 trillion yuanBy November 25 of this year, the index had decreased to 3264 points, yet the total market valuation increased to 619.71 trillion yuan

This counterintuitive result was primarily due to the influx of new stocks into the market.

Upon reviewing the statistics, we see that between the end of 2020 and now, the cumulative market value of stocks newly included in the SHCOMP stands at 12.88 trillion yuanIf we subtract this figure from the current total market valuation, the inference drawn reveals that the total market value of stocks included before this surge would amount to around 490.86 trillion yuanThis presents a slightly positive figure—suggestive that, under these conditions, the index should align closer to an estimated value of approximately 3500 points.

Another key issue contributing to the growing weights in market evaluations is the decreasing elasticity of the SHCOMPAs the total market capitalization has climbed, the fluctuations of the index have been remarkably muted2023 has witnessed one of the more tumultuous years in regard to market fluctuation, yet the year’s volatility has registered only a modest range of 35%. When viewed against historical backdrops, such as the fluctuations of 50% or even 100% in previous years, this presents a remarkable contrast.

Given these considerations, it becomes vital for investors to turn their attention towards component stock indexes, such as the CSI 300 and the ChiNext index, to gain a more accurate depiction of market trendsThese component stock indexes have effectively navigated the pitfalls of distortion that plague the SHCOMP.

Globally, component stock indexing has become a standardized method of index construction, with renowned indices like the Dow Jones Industrial Average or the S&P 500 modeling this structure

The beauty of a component index lies in its fixed number of constituent stocksIf a stock underperforms and sees its valuation dip due to poor performance, it can be substituted by better-performing alternatives—thereby refreshing and boosting the index with superior stocks over time.

This year, there has been a remarkable growth in the popularity of ETFs in China, which predominantly target these various component stock indicesAlthough there are ETFs that track the SHCOMP, their scale and clout don’t hold a candle to those pegged to broader indices like the CSI 300, CSI 500, and ChiNextThis indicates a market preference and a growing recognition of the importance of robust and responsive indexes.

Inevitably, while the SHCOMP enjoys the spotlight as a significant focal point for attention in Chinese equity markets, it falls short as an effective barometer of market performance