China Stocks: A Pause in the Party?
The awe-inspiring numbers coming out of China these days will reassure the global and local investors who have bought into the proposition that this $2 trillion-plus economy is a can't-miss buying opportunity.
On Jan. 10, China reported that its two-way trade with the rest of the world hit $1.76 trillion in 2006, while its global trade surplus shot up 74% to an all-time record high of $177 billion. The same day, an initial public offering by the country's biggest insurer, China Life (LFC), more than doubled in value to $4.74 on the Shanghai Stock Exchange. The bourse's benchmark index touched a new high and the combined market capitalization of stocks traded in Shanghai and Shenzhen broke the $1 trillion market for the first time.
Mainlanders, at least those who follow the currency markets, got another boost to their national pride a day later. For the first time in 13 years, the value of the yuan vs. the U.S. dollar actually exceeded the Hong Kong dollar's fixed-rate cross-rate with the greenback. For Hong Kong residents of a certain age who tended to look down on mainland Chinese, the idea of China boasting a stronger currency than the former British Colony is a bit hard to take.
True, these are just numbers that most ordinary Chinese don't scrutinize, and it's easy to overstate their psychological impact on the markets. Yet it is tempting to look at the explosive growth of China and draw parallels to the gold-flakes-on-sushi-era of late-1980s Japan or the dot.com euphoria in the U.S. toward the end of the '90s, given the instant wealth being generated among investors at the moment.
A Dangerous Ride?
There has been a Greek chorus of economists at Western investment banks such as Morgan Stanley (MS) and JP Morgan (JPM), and credit agencies such as Standard & Poor's, issuing blunt warnings that this won't last. (Standard & Poor's, like BusinessWeek, is a unit of The McGraw Hill Cos. (MHP)) Yet mainland day-traders and foreign investors alike continue to plow serious money into Chinese stocks traded on the mainland or exchange-traded funds that track big-listed mainland stocks.
Are they nuts? Even big-league market participants—who rode a market in 2006 in which A-share stocks jumped nearly 130% as measured by the Shanghai and Shenzhen 300 Index—are baffled by the mania that has gripped domestic investors.
Richard Hung is a board member and the biggest individual shareholder of Shanghai-listed Zhejiang Hisun Pharmaceutical, whose shares vaulted 10% on Jan. 10 and which boasts a price-to-earnings ratio of 40. "Nobody understands this market," he says, and other than his stake in the drug company he is steering away from Chinese stocks. "The A-share market for me is very strange," he says, adding, "I invest in New York and London but not in China."
Time Your Exit
However, the psychology that typically drives an investment bubble—in which fresh money chases asset classes delivering killer returns until, well, they don't—is difficult to break free of. There's always a nagging suspicion one is missing out on the investment opportunity of a lifetime, one that will put the kids through college or bankroll that vacation home on Maui.
S&P chief technical analyst Mark Arbeter recently issued a disturbing appraisal of the exploding trading volumes and price spikes with the iShares FTSE/Xinhua China 25 Index Fund (FXI) and similar China-linked investments, with this blunt warning, "Don't be the last one out the door." He points out the "FXI has spiked over 26% since Nov. 28, and 13.5% since Dec. 21." Can you say mass speculation (see BusinessWeek.com, 1/9/07, "Stocks: The Chinese Correction")?
Even bullish stock analysts believe that some sort of correction in the A-share market, traded primarily by Chinese domestic investors, is due. In fact, they add, one would be welcome at this point. That's especially true of Chinese bank stocks, which have raised billions in the A-share market as well as in Hong Kong, where foreign investors have far easier access.
Small Fish in Danger
Jing Ulrich, head of China equity markets at JP Morgan in Hong Kong, notes that some big mainland banks are trading at richer price-to-book value multiples than Citigroup (C) and HSBC Holdings. While still bullish long term, he says, "I think a correction at this point is warranted," (see BusinessWeek.com, 1/9/07, "China Bourses: Fasten Your Seatbelts?").
Market-timing investors and casual day-traders are probably most at risk in the months ahead in a market like this. If anyone is going to get hosed by a sudden lurch downward, it is this crowd. But could China experience the vast wealth destruction that visited stock investors in Japan early last decade or in the U.S. when the dot.com boom went bust?
The odds are low if you believe (as many analysts do) that China is still in the midst of a long-term growth wave. This economy has clocked near 10% growth over the last five years, and most economists predict the same rate, or slightly lower, the next couple of years out. Foreign investment continues to pour into the country, and Standard Chartered senior economist Stephen Green thinks China's trade surplus will swell by 33% this year to $237 billion, another record (see BusinessWeek.com, 1/8/07, "China's Living-Large Trade Surplus").
New and Improved Listings
All this is why Lorraine Tan, vice-president of S&P Equity Research for Asia Pacific based in Singapore, thinks while there could be a correction, the Chinese "mainland markets will continue to go up about 25%" in 2007. She points out that after the five-year bear market that hit both exchanges earlier in the decade, "share ownership levels hasn't moved up beyond historical levels."
While a 25% return may seem disappointing to punters who basically doubled their money in 2006—it is the kind of performance investors in other markets would die for. Dorris Chen, a financial industry analyst at BNP Paribas, also points out that the Chinese government has done a fairly good job of lining up better quality mainland companies to raise capital on the domestic bourses, as opposed to the dodgy ones earlier in the decade.
"There are more new listings in the pipeline and that will attract liquidity," Tan says, in a savings-rich China with low domestic interest rates and an overheated housing market that looks even riskier than stocks at the moment. "The overall quality of A-share listings is much better now," she contends.
So if a stock market downturn comes, the consensus view is that it won't be a deep or lasting one. In any case, everyone is getting too rich right now to worry all that much. For stock investors knee-deep in Chinese stocks, it is party time.
From: BusinessWeek, By Brian Bremner
Date: January 11, 2007 Back