Flashes of red have so far prevailed since the Shanghai Stock Exchange re-opened on Jan. 4 following the New Year break. With fiscal cliff in the United States temporarily resolved, the global stock market performed pretty well on average. Furthermore, PMI data showed the further recovery of China's national economy, bringing additional enthusiasm to the market. The Shanghai Composite (SHCOMP) Index rose from 1949 to 2269, an increase of over 300 points. However, how long can the optimism continue if the market continues to ignore the interests of the medium and small investors?

Despite December's rebound, a bear market prevailed in China for most of 2012. On December 29, the SHCOMP closed only 3 percent higher than at end of 2011. Market performance of the SHCOMP can't compare with Dow Jones Index in the United States, Hang Seng Index in Hong Kong, Nikkei Stock Average in Japan, CAC 40 index in France and Financial Times Stock Exchange 100 Index in England. There are views that China's A-share market has a fatal illness. Although I am not as pessimistic as they are, I do think the accumulated problems of the stock market need to be resolved by smart policy solutions.

The rise of fall of A shares in the Chinese market is neither connected to the entire real economy nor related to enterprises' performance. So, it is difficult to make quantitative analyses or rational forecasts, let alone short-term speculation or long-term investment.

For example, Qualified Foreign Institutional Investors (QFII) entered the Chinese market with the identity of mature foreign investors; its investors have both mature market operational experience and strong research team on stock market. But, in the past three years, the average loss rate for such investors reached 33 percent. The situation on the domestic small and medium-sized investors is worse. For example, investors who bought XCMG Construction Machinery Co Ltd (000425: Shenzhen) with 29 yuan (US$4.65) in March of 2012 lost 63.4 percent. Five years ago, when the PetroChina Company Limited changed from H shares in Hong Kong to A shares in Chinese mainland, stock prices fell up to 81.92 percent and about 570 million yuan (US$91.47 million) was lost. If investors want to gain their capital back on dividends, they will have to wait at least 148 years, according to some estimates. If the situation doesn't change, making China's stock market better will continue to be a fantasy.

On one hand, many medium and smaller investors fled from the stock market as their losses mounted. On the other hand, more than 800 companies are squeezing into the market at present. The contrast shows the fact that as long as the companies can become listed, shareholders of these companies can become rich overnight.

How long can the stock market of China maintain growth under such conditions? Where is the stock market heading in 2013? In fact, existing regulation has caused the current situation, because current regulation of the stock market is not only related to the distribution of interests among different parties, but also determines incentives that affect people's behavior. The stock market of China was built on the ground of a planned economy and regulations led by government power. However, the modern stock market is a democratic and impersonal market. The clash between government planning and independent market forces has thus led to this odd predicament.

The continued rise of the A shares since December 14 showed people's strong expectations for the new leadership to adjust policies. These expectations are not only about adjustments to economic structure and growth speed and about urban construction ― more importantly, the new government will launch a series of major reforms which seek to eliminate injustices in every walk of life. China's next president, Xi Jinping, emphasized the need to break the barriers of interest consolidation, while the country's next premier, Li Keqiang, said that reform is the "biggest bonus." The new leaders hope to incite major reforms which take China's economy in a new direction.

From the perspective of the stock market, these reforms should focus on building a fairer market by adjusting the interest relationship, in order to allow small and medium-sized investors to better enjoy the achievements of China's economic growth. Currently, however, market activities seem to put more emphasis on urban expansion, which requires huge proportion of fixed investment growth, and further relaxation of central bank's monetary policy. As China's reform agenda begins to clash with vested interests, the direction of the economy and the stock market remains uncertain.

A key point will be whether the government can eliminate vast inequities in the system through sweeping policy reform, which would clean up the stock market's legal system so it could defend all interests equally; defining the function of the regulators and establishing strict supervision system on regulators; decreasing intervention in the market by those who hold power; establishing a system of protections for small and medium-sized investors; and deflating the real estate bubble.

China's domestic stock performance 2013 will largely depend on whether the government can successfully implement such reforms. If these efforts fail, market performance in 2013 will continue to remain uncertain.

The author is a columnist with China.org.cn. For more information please visit:

http://www.ccgp-fushun.com/opinion/yixianrong.htm

(This article was first published in Chinese and translated by Lu Na.)

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.