By staff reporters Qiao Xiaohui and Wang Xiaolu

(Caijing.com.cn) Regulators turned cautious toward China's rising A-share stock market in early July, when a new rule from the China Banking Regulatory Commission (CBRC) prohibited banks from tapping wealth management funds for stock investments. Moreover, mutual funds were told to stop dabbling in equities.

Another cautious step came July 9 when the People's Bank of China announced it would issue one-year notes, signaling a mild adjustment in monetary policy.

And a few days later, CBRC ordered the semi-official China Securities Depository and Clearing Corp. to cease opening securities trade accounts for trust companies, effectively barring the use of trusts to buy stock through initial public offerings.

But Beijing was only tapping the brakes. The government tone changed – and pleased stock market bulls -- a few days later when, at an economic conference, Premier Wen Jiabao said the government should stick to "a proactive fiscal policy and a relatively relaxed monetary policy."

The premier's message encouraged investor optimism. So after a brief respite while regulators played the caution card in early July, the bull runs resumed on the Shanghai and Shenzhen stock markets.

By mid-July, the market indexes reached their highest levels in a year on rising trading volumes. The Shanghai Composite Index closed at 3188.55 on July 15, while the Shenzhen index finished at 1,307 points.

Once again, government policy had moved the markets.

Institutional investors played the bull market aggressively – and successfully. Lipper, a Reuters fund research company, reported equity fund earnings rose 50.67 percent during the first half of the year. China's QFII funds for foreign investors soared 62.79 percent.

Private funds scored higher returns than public funds; many posted yields exceeding 100 percent. Some investors turned more cautious after the Shanghai index hit 3,000, a public fund manager said, but few expected the market to fall.

Savings accounts have been tapped for stock purchases by investors trying to stay a step ahead of what many see impending inflation. Deposits in standard bank accounts rose faster than savings account deposits in June.

A CICC strategy report July 6 said the change in savings deposits deserved more attention because, if the trend continues, stock indexes can be expected to soar.

Behind the Numbers

Fundamentals can shed some light on current market behavior, said Yu Jun, executive general manager for research at CITIC Securities. He said producer price indexes were still in negative territory even though macroeconomic conditions turned better in the first half of the year – an indicator that industrial product prices had bottomed out and mid-tier companies were unlikely to post better financials this year.

A report by Wang Tao, chief China economist for the investment bank UBS, said the Chinese government would likely discontinue its economic stimulus programs soon. But she argued Beijing would not overhaul current macroeconomic policy due to concerns that export trade and the global economic outlook are still, by and large, grim.

Indeed, as Wang's comments indicate, the central government's policy orientation has become a key focus for market watchers. Some worry the wrong policy could end the current rally.

But so far this year, government policy has encouraged market growth. Regulators recently gave a green light to resuming IPOs but initially chose to allow new stock offerings in three growth sectors, excluding blue chip companies. The amount of money to be raised in each IPO was to be less than 1 billion yuan.

After that market test, regulators opened doors to bigger deals. They approved Chengyu Highway for an IPO on the A-share market to raise 1.7 billion yuan. Later, blue chip giant China Construction Corp. got regulatory approval to raise as much as 42 billion yuan. In addition, regulators lifted a 10-month suspension on corporate bond sales.

An investment banker told Caijing that regulators decided to control the financing pace out of concern that stock prices would start slumping. IPOs, they reasoned, would encourage a secure market.

Guilin Sanjing (SZSE: 002275) opened on its IPO debut July 10 at 32.50 yuan, up 64 percent from the initial offer of 19.80. The stock soon soared to 39 yuan, hitting the daily limit. Likewise, Zhejiang-based Wanma Cable (SZSE: 002277) opened at 22.50 yuan, up 95 percent from its offer, before rising another 20 percent that day.

"Controlling the pace and scale of IPOs results in market demands outstripping supply," said an investment bank source. "This is a natural outcome."

Policy Phenomena

Where will the A-share index go next? The answer is tied to monetary policy.

"We don't worry that market prices will slump in the third quarter," said a private equity fund manager. "As for the fourth quarter, it will require some observation. But, personally, I am more pessimistic about next year."

As of July 14, a total 267 out of 769 companies that list on the Shanghai and Shenzhen exchanges reported improved financials for the first half of the year. Another 31 companies said they expected to remain profitable.

Gui Gaoming, chief analyst with Shenyin Wanguo, said upbeat expectations bolstered the stock market during the first six months of 2009. But it's unclear whether those expectations can be maintained through the second half of the year.

Gui argues that if expectations are not matched by real profits, the Shanghai stock index cannot expect investor support to continue. But policymakers are never far behind.

1 yuan = 14 U.S. cents