Trader Talk

Here's why China rallied despite dismal economic news

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The mainland Chinese stock market rallied Monday, clocking its best gains in five months, despite dismal economic news.

The up 4.9 percent, and the Shenzhen up 4.5 percent, but is down 0.1 percent. Huh?

It's pretty simple. The Hong Kong market reacts to economic news. The mainland China market reacts to news and rumors of additional stimulus.

The economic news was uniformly disappointing. The producer price Index, an indicator of inflation—and demand for goods at the wholesale level—hit a better than five-year low.

Read More China stocks outperform cautious Asia, up nearly 5%

On trade, exports were down 8.3 percent in July compared to the same period a year ago, while imports were down 8.1 percent, now down nine months in a row.

But the Shanghai and Shenzhen markets rallied, largely on speculation even more stimulus would be coming.

They're probably right. A number of reports have suggested the government would be getting even more involved in owning stocks. Apparently the government will be creating at least two additional sovereign wealth funds that will buy state-owned enterprises (SOEs) and use their ownership to improve their financials.

What's odd is that these are companies in which the government still owns the majority of shares or has a controlling interest.

Talk about doubling down on bureaucracy! We're creating another entity to control something we already control!

This has created speculation that a new wave of mergers among SOEs will be coming.

Talk about activist investing! Merge or get arrested. Or worse.

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By the way, SOEs are among the biggest companies in China, including oil and gas companies like SINOPEC, PetroChina, and CNOOC, as well as Aluminum Corporation of China and Bank of China.

There were several stories over the weekend about the growing role of the China State Finance (CSF) agency and the significant stocks they likely have amassed positions in. Bloomberg looked only at disclosures for large investors, and noted that the CSF appears to have amassed fairly significant positions in many industrials, particularly railroads.

It noted significant positions in China Railway and China Railway Construction, for example. In the case of China Railway Construction, one of the biggest railway construction contractors (which trades in Hong Kong), Bloomberg noted that it had amassed a 9.1 billion yuan position.

The math is a bit fuzzy, but working with a market capitalization of 264 billion Hong Kong dollars, that would equate to a roughly 5-percent position. That would make the CSF the second largest shareholder, after the parent company, which owns 65 percent of the company.

And who owns the parent company? Why, the Chinese government. China Railway Construction is an SOE.

Get it? The government is creating multiple levels of its own ownership!

As one trader noted to me this morning, this explains why there are so few buybacks in China—there would be no stock left!