China's stock markets tumble to new lows.

That makes prospects bleak for the imminent launch of the second board - and raises further questions about the regulator''s approach.

The Shenzhen and Shanghai stock exchanges tested new lows Monday, with the Shanghai composite index down 33.34 points or 2.26% to 1438.74, its lowest level since December 8 last year, when the index dropped to 1436.66. The Shenzhen composite index dropped to 367.44 points, a fall of 2.8%.

In the last two months alone, the Shanghai A-share market has dropped some 20%.

Given the macro-economic uncertainty the slump is not surprising. Fears of an interest rates hike to cool a possibly overheating economy are causing investors to wait on the sidelines.

Symptomatic of the malaise was another new low in the IPO market, recorded by Changfeng Motor, after it offered seventy eight million shares for the first time on Monday. Its one-day gain was 6.52%.

That is a dramatic reduction compared to past IPOs. The mainland markets have rules-based IPOs in which the PE is fixed at between 15 and 20 times earnings to give investors easy money in the secondary market. In the secondary market the ratio can be as high as 35 times.

Changfeng's modest result is just the latest in a line of shrinking one-day gains. Since April, in chronological order, Dongli Power put on 144%, Kangenbei 77%, Mayinglun 43.64%, and Longyuan Construction 17%.

Some mainland observers point out that part of the blame should be placed with the PE ratio at which the IPO was allowed to go ahead by the CSRC. Set at 16.24 times, it rose to 17.3 times on its first day. But this is already higher than the sector average and much higher than Changan Motor, which is trading on 10 times.

Another leading comp, Jiangzhun Motor, trades at 17 times. Local bankers say the new arrival's high PE ratio does not make much sense in a sector where vicious competition and the influence of the WTO are causing prices to drop almost daily.

Some companies have more to complain about than modest first-day gains. Bohui Paper manufacturing, which launched just five days ago, dipped under its issue price Monday. Even for the A-share market, where shares regularly surge on the first day before collapsing within a few weeks or months, that was unusually fast.

There is a clear correlation between one-day gains and momentum on the stock market. In 2000, the main board put on 52% and new issues went up 151% on average. Those with small free floats, defined as under 80 million shares, put on 174%. Then 2003 was a poor year for the stock market, but the average one-day gain was still 72%, or 77% for the smaller IPOs.

These recent modest gains contrast with the beginning of this year, which saw some dramatic gains during the first quarter.

The company which manages the trunk road No. 9 launched an IPO in February at an issue price of Rmb 5.03. The share price jumped to Rmb 20.98 on its first day.

Observers say it is pointless for China's speculative investors to worry about fundamentals, or for companies to be genuinely interested in satisfying the dictates of the market, as opposed to fudging their figures to jump through the CSRC's hoops. Investors' major concerns are not the quality of the company but whether he or she will get a lucky number from the computerized distribution system that will permit him a certain gain. And the company knows its IPO will be a sure-fire successs thanks to the deliberate underpricing.

Most seriously, poor sentiment could affect the launch of the long-awaited second board in Shenzhen, or the small to medium enterprise (SME) board as it is called in China.

It has been decided to give this sector priority this year, rather than the original plan several years ago for an IT start-up board. That is because it has long been recognized the SME sector finds it very hard to raise funds from banks.

Strange to Western eyes, companies will be bundled together for their launch. This represents another of the CSRC's administrative measures to speed up the long line of companies waiting to list and is based on the rationale that life will be made more difficult for speculators.

But however arcane the methods used by the CSRC to convince investors that incoming companies will escape the scandals which have plagued IPOs in the past, it isentiment on the main board, which could prove crucial to the success or failure of the new board.

That will continue to be technical and momentum-based until the CSRC permits fundamental issues, such as the strength of the management and the profitability of the company, to assume a more important role. When these are lacking, even if momentum on the main board does turn positive, it is not likely China's investors will be getting a better batch of companies to invest in.

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