In recent days there has been quite a bit of discussion in blogosphere about a possible bubble in the Chinese stock market (the Financial Times also has a nice, short piece on the topic). Perhaps the Chinese are about learn a harsh lesson about capitalism and the markets? While I’m not putting any money on the line, I do find all this talk fascinating. Here is some of what Morgan Stanley, UBS, and Goldman Sachs have to say on the matter:
Goldman Sachs Global Insights, Equity Strategy (11 May 2007):
1Q2007 EPS growth for the China A-share market came in at 82% yoy, surprising consensus on the upside. However, explicit and implied valuation methodologies suggest current valuations are demanding and seem to have outpaced the improvement in market fundamentals. Market trading statistics, liquidity indicators, and anecdotal evidence all point to optimistic, if not exuberant, sentiment in the domestic market. Encouragingly, it appears that our colleagues’ positive thesis of November 2006 has materialized, albeit a bit too quickly, as the domestic A-share market has risen over 150% since the second half of 2006, showcasing one of the greatest turnarounds in the history of the Chinese equity market. As speculation continues to be nurtured among domestic retail investors, our colleagues see genuine risks of market euphoria materializing if regulators fail to step up their efforts to contain market irregularities.
Additional points from another GS note, ‘China: Portfolio Strategy: Strained Valuations’ (10 May 2007):
– All in all, is it worth paying over 30X 2007E P/E for the A-share market?
– As growth momentum seems to fire at all cylinders (macro, industrial segment, SOEs and listed universe), it is probably not difficult to relate the strong market performance in the A-share market to the continuing upside earnings surprises and rising market expectations on future earnings.
– Undoubtedly, A-share companies’ fundamentals have strengthened significantly in recent years and an earnings turnaround story remains well in place, the justification for valuations nevertheless seems questionable.
… assuming that China’s cost of equity should be lower than that of a mature market like that of the US, we believe a forward multiple of around 27X for Chinese stocks would seem difficult to justify.
– While it may seem immature to suggest that the A-share market is already in an irrational stage, particularly at the current stretched but not outrageous valuations, all these indicators lead us to believe that risks of the market developing into a bubble are building up.
UBS Market Comment, China Market Strategy ‘Where China shares are going? #3’ (11 May 2007):
H-shares are rationally priced Since the start of 2007, A-shares have gone up 50%, while H-share performance has stayed flat. We believe foreign fund managers are concerned over the A-bubble, and are being cautious about H-shares.
… liquidity has pushed A-shares into a bubble to yesterday’s close of 4,013.
Morgan Stanley Investment Perspectives:
The recent stock mania, with new accounts opened exceeding 300,000 a day, is largely fuelled by speculations of individual investors. The country’s entrepreneurship will face serious challenge if the current asset bubble continues the pumping of industrial capital into financial markets. It will also move talent from entrepreneurship to speculation, if prolonged. China must build its future on industrialization, and it is facing a historical opportunity to upgrade industrially. Regulators must make a tough call and restrain the asset bubble and speculation.
And a few of my thoughts:
– The consensus of opinion is not surprising – after all, the street still has the lessons of the internet boom fresh in it’s memory. From the perspective of the analyst, there is more to lose from untamed optimism than from the cautious, cautious approach. It will be interesting to see how things pan out. I’m sure the optimists will win out over the long-term, but it’s going to be bumpy ride along the way.
– I am a little surprised at advocacy of greater regulatory intervention by these totems of the free market (GS and MS) , and I would like to believe the market could work itself over time. There comes a point where the bursting of a bubble could have deep, lasting effects on the real economy, but I don’t believe we have reached that point. Also, in terms of the long-term outlook for investors, a natural correction is surely far more valuable than a dampening of enthusiasm by the authorities.
That said, I accept the role that unnatural distortions may have played in driving the market to these dizzying highs.
– Some people believe we are already well into a bubble and that the greater-fool theory is driving up prices. Given the rate of wealth creation in China, the massive population (>1.32bn), and the number of brokerage account being opening up each month, it looks like the supply of potential fools could be plentiful.