Watch China Inc.’s Insider Selling

(Bloomberg Opinion) -- Foreigners are finally warming to China.

It's no surprise: In just two months, the country's stock market has done a 180. Investors from abroad were net buyers of more than 120 billion yuan ($18 billion) of shares this year through Hong Kong's Stock Connect. In hindsight, MSCI Inc.'s decision to include mainland stocks in its benchmark indexes last May seems like a wise one.

Late Thursday in New York, MSCI said it will increase the weighting of A shares in its China indexes and related benchmarks by raising the so-called inclusion factor – the ratio of mainland stocks' market cap that's included in the index – to 20 percent from 5 percent. As a result, China's stock market can expect another $60 billion of buying, estimates Goldman Sachs Group Inc.

This flood of foreign money is a bullish sign for Chinese stocks, enthusiasts say.

Not so fast.

Take a look at who owns China's $6.4 trillion stock market. At 2.2 percent, foreigners' sway is tiny. And while local retail investors are blamed for the 2015 stock-market frenzy, they hold only 20 percent. The majority of shares are still controlled by insiders: founders, management and parent holding companies.

As early as May 2017, China's securities watchdog tightened regulation on stock sales by majority shareholders. The move was intended to protect retail investors and strengthen corporate governance.

But that hasn't stopped insiders from selling, even at the risk of facing the regulator's ire. In the three weeks ended Feb. 23, such investors – concentrated among firms listed on the private-sector ChiNext board – were net sellers of more than 4 billion yuan of shares, according to data compiled by Sinolink Securities Co. On Monday and Tuesday, when daily trading volume exceeded 1 trillion yuan, close to 80 companies filed insider-selling disclosures with the Shanghai and Shenzhen exchanges.

It's not hard to see why. China's private sector is battling a crisis of confidence. Entrepreneurs are fleeing the country and curtailing their spending on equipment and machinery. The central bank's credit disproportionately benefits state-backed firms. Nowadays, local government financing vehicles can issue bonds more cheaply than their private-sector peers. High-yield enterprises – real estate developers, for instance – still can't raise new notes onshore.

If you were a lucky entrepreneur at a ChiNext-listed company, wouldn't you maximize this rare bull window and sell, too?

Those betting on foreign money to stabilize China's stock market are simply delusional. As developing countries from Indonesia to Argentina have discovered, a nation that relies on hot money from abroad is an unstable one. Will these investors stay in China's stock market if Beijing can't reach a trade agreement with the U.S., or the Federal Reserve continues to taper its balance sheet?

MSCI's indexes are just guidelines – portfolio managers can always go “off the benchmark.” If Beijing really wants a slow bull, forget about lobbying index providers and massaging trading volumes. Lift private entrepreneurs' spirits instead.

To contact the editor responsible for this story: Rachel Rosenthal at rrosenthal21@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.