On January 24, the Shanghai A-Share index, which represents the index for stocks traded by RMB in the Shanghai Stock Market, hit a record high in its 14-year-history — closing at 2994.28, an increase of 94% in less than six months. The Shanghai stock market has also seen record trading volume, reaching 110.7 billion yuan ($13.8 billion) on January 23, 10 times higher than it was in mid-August 2006. (“A” shares refer to common RMB stocks traded in RMB; “B” shares refer to special RMB stocks traded by foreign currencies.)

“The [average] PE multiple in 2006 is at 25. This number is very high, but it’s not crazy. However, I believe the valuation on some of the financial stocks has completely gone crazy,” commented Andy Xie, a former economist for Morgan Stanley Asia Pacific, in an article published in early January in Caijing, a finance magazine. “Some Chinese banks are now the most expensive banks in the world, [even though] they haven’t [yet proven] they [can] make a profit. Their profits in the last economic cycle were a gift from the government instead of [a result of] their own operations. The banks’ PE multiples should be at a lower level.” Another financial institution, Beijing-based China Life Insurance Company Limited, the largest life insurance company in China, was listed on the Shanghai Stock Exchange on January 9, 2007, and by mid-January had reached a PE multiple of more than 120.  


Although the market has shown signs of a mild correction since the end of January, to most investors, the rally in the last six months represents a strong indication that China has finally moved beyond the bear market that started in 2001.


Fu Xuedong, chairman of Guotai Junan Allianz Fund Management Co., the first Sino-foreign fund management company in China, pointed out in an interview with China Knowledge at Wharton that with China’s economy growing at a rate of 10% a year, the bear market in the last five years was not normal. “The recent upturn of the stock market has two major” implications, Fu says. “First, it is compensation for the bear market over the past five years.” Second, it shows an unprecedented confidence in the stock market itself. “The nearly-completed non-tradable share reform started in 2005 — aimed at eliminating non-tradable shares in order to improve the market’s efficiency and transparency – “has been going on successfully, and has set up a sound base for other institutional improvements,” which has led to this confidence,” Fu says.


He has a different point of view than Xie. “I don’t think there is a bubble in China’s stock market,” Fu says. “It’s true that some stocks are too high, but on the whole, the market is normal. The stock market can’t be completely rational. In recent months, investment fever has been pushing the price up too fast. Excessive liquidity, appreciation of the yuan and optimism all have contributed to this recent passion to get into the market.” However, Fu continues, “The market will digest part of this blind optimism in the near term and it will be more rational in the next stage. It’s normal to see some corrections at present.”


Demands Are High


For now, however, individual investors and security funds are entering the market at a rapid pace. According to figures from the China Securities Depository and Clearing Corporation, on January 23, new accounts opened on the domestic stock market in China hit a record 97,941 for one day, 18 times higher than the number on August 23 last year. What’s more astounding is the number of new accounts opened for mutual funds. On August 23, 2006, there were 1,286 new fund accounts opened; that number jumped to 201,897 on January 23, 2007, 156 times higher.


Critics say that the bull market has whetted people’s desire for wealth more than ever. “Chinese people’s financial awareness has never been so elevated,” notes Huang Yongdong, an anchor and commentator for a finance TV program produced by Shanghai Media Group.


Credit Suisse Group estimates that in the last six weeks of 2006, there were 250 billion yuan ($31.2 billion) flowed from banks to the stock market in China. Among the 250 billion, about 150 billion yuan ($18.75 billion) went to mutual funds and the other 100 billion yuan ($12.5 billion) went to stocks. One fund raised 40 billion yuan ($5 billion) during one day in December last year. “This is totally unprecedented in the history of mutual funds in any other country,” noted Tao Dong, the chief economist at Credit Suisse Group Asia Pacific, in an article published in 21st Century Business Herald on February 5. “The grassroots investors who can’t even read the share price sheet began to shift their money from banks to the equity market because they don’t want to miss the opportunity of getting rich. This transformation will have a far-reaching impact on China’s banking system, equity markets and its economy and policy making as well.”


The Chinese authorities clearly can’t ignore the investment frenzy, and in fact have taken some modest measures to cool things down. Licenses for new mutual funds have been put on hold and banking regulators are investigating the use of personal loans to buy stocks.


The People’s Bank of China ordered banks to boost reserves four times in the past year to reduce the money available for investment. Banks now must set aside 9.5% of deposits after a half-percentage-point increase. Meanwhile, the country’s administration of foreign exchange has increased the foreign exchange purchasing quota for individuals from $20,000 to $50,000. As of last year, people in China have been allowed to buy dollars, but only within a certain limit, or quota, set by the government.


“But today’s situation is different. When 15 trillion yuan of savings begins to move from the banks … macro-policy control” is not as effective, Tao Dong argues. “I believe appreciation of asset prices will be one major theme for China in 2007. The stock market will rise, and the property market will rise, too. Don’t forget that the 150 billion yuan which the mutual funds have financed in recent months haven’t been invested yet.”


Andy Xie, however, has a different opinion about the role of the property market. The excessive liquidity, the popularity of mutual funds and the contraction of the property market are the main drivers behind the equity market’s bubble in China, he says, adding that while most of the markets were not doing well in 2006, capitals all over the whole world are chasing after the winners, such as China, India and the U.S.


“Capital from Hong Kong has also joined this banquet,” says Xie. “Most of the property developers have become fund managers now. In fact, the performance of the whole economy of Hong Kong is like a mutual fund management company which is betting its future on the bull market of the mainland.”


Indeed, there is evidence suggesting that international buyers are obsessed by China. Half of the record $22.4 billion invested in emerging market funds last year went to China funds, according to Emerging Portfolio Fund Research in Boston. And during an “Access China Forum” held by Deutsche Bank in Beijing in early February, the bank’s Asia Pacific chief economist, Ma Jun, told the Chinese press that the quota for “QFII” [Qualified Foreign Institutional Investor] has been in short supply abroad. (The government sets a limit on how many A shares foreign institutional investors can buy in China.) “In Hong Kong, many international investors stand in lines to ask for shares of the quota,” Ma Jun notes.

Benchmark for a Bubble


Andy Xie is critical of the recent boom in China’s assets prices. “I think the average long term PE multiples for China’s stock market should be at 15 to 20. When it’s over 25, there is a bubble because the fundamentals of China’s listed companies haven’t been substantially improved. The actual interest rate has dropped 8% in the last 10 years, which is a major reason for the rising profits of corporate China. Meanwhile, China’s fast-growing economy doesn’t necessarily lead to fast-growing profits. China’s economy is investment-driven, which makes the profits less.”


Tao Dong of Credit Suisse Bank says that the PE of A shares now is around 35, which is higher than the world average of 16. “But it’s not completely reasonable to measure China’s A share performance [against] international standards,” Tao argues. “China has capital control. The benchmark for Chinese investors is the interest rate of Chinese banks instead of the global PE level.”


A senior manager of a Sino-U.S funds management company in Shanghai told  China Knowledge at Wharton that the recent rally is a correction for the bear market and a reflection of the potential of China’s economy. The next stage will be expected fast growth. “The non-tradable share reform has finally kept the interests of major share holders, minor share holders and corporate management in one line … In addition to easily available capital, excessive liquidity, revaluation of assets and control of the property market, one important factor is appreciation of the yuan. Although the yuan has appreciated 6% already, it hasn’t arrived at its expected level yet.” On the other hand, he commented, “The Chinese government needs a bull market in 2007 to proceed with SOE (state-owned enterprise) reform. Besides, a bull market without great fluctuation is necessary to provide a mild climate for the index future, a new finance derivative on the stock market which is expected to be issued this year. Lots of companies are doing well, making more money.”


Some individual stocks have bubbles, including the Chinese Life Insurance and the Industrial and Commercial Bank of China, this manager conceded. “But the whole stock market is doing fine,” he added. “It has the potential for a rise in 2007. Finally, the China market is selling at a premium [as is] the India market. If you are looking for an investment without risk, you could buy bonds.”


A Bull to Last or Blast


Fu Xuedong, chairman suggests that the prosperity of China’s stock market is determined by two factors. One is the involvement of China in the world’s economy and the other is the appreciation of yuan. He also points out that “excessive liquidity pushing up the asset prices does not only happen in China. Liquidity is a global phenomenon. It can’t be solved by China alone.”


He is confident about the potential of the equity market. “China could slow its step to appreciate the yuan, but it’s unavoidable that the stock market will rise. We have to [be] rational to prevent bubbles, but if some fundamental directions cannot be reversed, then the upward trend will continue,” Fu concludes.


According to Huang Yongdong, “Some blue-chip stocks’ return to A shares will improve the quality and profits of the whole stock market. Yes, the quality of many listed companies remains [poor],” Huang says, “But talking about bubbles doesn’t necessarily translate into blasts. Many institutions invest in future growth. China is not perfect and it has problems and uncertainties. A country with any future will have risks, too.” Even Xie suggests that the bubble won’t pop too soon. Driven by consistent liquidity, the bubble will be likely to expand and last for a long time. “I never said you can’t buy A Shares now,” he says.


Meanwhile, the government could increase the supply of stocks to meet demand while it continues to try to reduce liquidity. There are also some experts lobbying for more diversity in the investment channels for individuals and policies to encourage further domestic consumption. On the whole, a drastically fluctuating stock market is not in accord with the goal of a “Society in Harmony” set by the current administration, observers note.

But while the economy can be regulated to some extent, the Chinese people’s irrational pursuit to get rich is hard to control. As one critic puts it, “the coming year will be a tough year for the authorities to strike a balance between confidence and over-speculation.”