Remember February 27, when the Shanghai Composite index plummeted by 8.8%, triggering a meltdown in stock markets worldwide and sending the Sensex into a tailspin in March? Well, the Shanghai index is not only hitting all-time highs every day, but is up 33% from the peak it made just before the crash. If the market was overheated then, it’s red-hot now.
Volumes have shot through the roof, with the value of trades in the Shanghai and the smaller Shenzhen market last Wednesday (2 May 2007) higher than the combined value of trades in the rest of the Asia-Pacific, according to Bloomberg data. And that’s in spite of the fact that day-trading is banned in China.
Most of the money pouring in is local, as investors discover the joys of making money the capitalist way. New trading accounts are being opened at the rate of around 3,00,000 a day. The Chinese media is full of stories about punters mortgaging their houses to speculate in the stock market. Surveys show that everybody is jumping on the gravy train, from pensioners to Buddhist monks to college students. Since the start of 2006, the Shanghai Composite index has surged 250% and it’s up 48% this year. This index includes both the yuan denominated A shares and the hard currency-backed B shares. The CSI 300 index, which tracks A shares listed on both the Shanghai and Shenzhen bourses, is up 191% over the past year and is now priced at 42 times reported earnings, according to Bloomberg.
The runaway rise has stoked fears of another crash. The Chinese central bank governor has said that he’s “concerned” about the build up of a stock market bubble, while the premier has said that his country’s current growth is “unstable, unbalanced, uncoordinated and unsustainable.” The worry is that the government may decide to raise interest rates, leading to a market crash.
But is the Chinese market all that irrational? Between March 2003 and December 2005, a period during which the Sensex went up by 208%, the Shanghai Composite fell 23%. Could it be that all that’s happening is that the Chinese are playing catch up? Before reforms in 2005, the majority of shares in the Chinese market were non-tradable and held by the state, which led to fears of massive dilution, a thin market and easy manipulation. It was the clean-up of the market that led to the current boom. And while it’s a fact that most stocks have reported price-to-earnings ratios above 40, Chinese companies listed in the A-share market saw their profits rise by 82% in the March quarter, compared to the year ago period.
However, the government would be only too glad to ensure that the frenzy doesn’t get out of hand. And with taxi drivers and retirees playing the market, most observers believe that a crash in the Shanghai market is imminent.
That may not be a bad thing. The mainland equity markets are not very important for the Chinese economy, although some bank loans may have been diverted to the stock market. Also, with the bulk of trading in the hands of local investors, the contagion impact on other markets should not be large. Nevertheless, a crash in Shanghai could very well lead to another bout of profit-taking, sending highly leveraged speculators scurrying for the exit in markets across the world, as happened last February. The ensuing panic would be the right time to buy.