The Shanghai stock exchange rebounded Nov. 29 — a day after hitting a three-month low — after the central government clarified new tax rules that household investors had been fretting over (namely, details behind a new corporate income tax to take effect Jan. 1). China's stock markets are nearly completely insulated from direct foreign investment, and prices rarely reflect the true underlying value of any particular company. Instead, poorly informed household investors (responsible for the bulk of both the Shanghai and Shenzhen stock market turnover), often make investment decisions based on their access to capital — and thus based on expected central government policies that would affect that access (e.g., interest rate increases, higher trading fees, etc.). Notable stock market fluctuations are, more often than not, knee-jerk reactions to Chinese policy rumors. Such rumors caused both the February and May record plunges in the Shanghai and Shenzhen stock exchanges. So at what point do such fluctuations become significant? They become meaningful when:

• Companies listed in both Shanghai and Hong Kong see their Shanghai share prices fall below their Hong Kong share prices (mainland share prices are so overinflated right now that a drop in prices is both expected and necessary to take excess hot air out of Chinese stock exchanges), or
• Chinese household investors start panicking and pulling out of mainland shares en masse. Most have not started moving their funds out yet, in the hope that they can ride out the downturn and recoup what would be losses if they pulled out now.

Even though China's stock markets are insulated from foreign investors, they are no less vulnerable than the exchanges in London or New York or Tokyo. Any stock market with freely fluctuating prices and shareholders with real money to lose leaves the economy exposed to unpredictable risk to an extent. In China, the biggest risk is policy unpredictability emanating from Beijing. Exuberance in Chinese equity has started to diminish somewhat, as Beijing's messages about its intention to crack down hard on inflated stock markets and/or the economy are finally getting through to consumers. Rising inflation for both food and oil is also beginning to hit investors' pockets and lessen the amount of disposable income they have to play with in stock markets. Consumer confidence also fell in November, a fact confirmed in a report published by Xinhua Finance Ltd. and eziData on Nov. 28. In the coming months, Beijing will continue using rumors of policy announcements to cool down stock markets as needed and to keep markets from plunging too far by issuing official policy clarifications. This strategy has started working in that perceptions in the Chinese market are shifting, even if only marginally.