China's exuberance undiminished by talk of asset bubble

By Patti Waldmeir and Xi Chen in Hong Kong Published: July 2 2009 03:00 Last updated: July 2 2009 03:00 China's stock markets have had a fabulous first six months of the year. And yesterday they began the second half in similarly fine fettle with the Shanghai Composite index breaching 3,000 points. The benchmark is up 65 per cent for the year, making Shanghai the best performing large stock market in 2009 and leaving it nearly halfway back to its October 2007 peak of 6,092. Like other economic indicators in China, such as sharply rebounding car sales and surprisingly robust gross domestic product growth, the mainland's stock markets have vastly outperformed expectations. The market's buoyancy has led some commentators to talk of another asset bubble. Analysts who follow the Shanghai market closely are divided over how great that risk is. For the moment, investors seem keen, in spite of the resumption of initial public offerings last month, which had been expected to damp their enthusiasm. Yesterday's 1.7 per cent surge to 3,008.15 left the Shanghai Composite at its highest level in more than 12 months and followed yet more good news about the strength of the Chinese economy. Expansion in the manufacturing sector continued for a fourth month, with the official purchasing managers' index increasing to a seasonally adjusted 53.2 in June from 53.1 in May. (A level of 50 indicates expansion.) Another purchasing manager's index, from the CLSA investment bank, also showed a rise in June, to 51.8 from 51.2 in May. "It is now safe to say that a sustainable recovery is well under way in China," Andy Rothman, CLSA China macro strategist, wrote in a research note yesterday. Even the long-awaited resumption of IPOs in China has not poured cold water on the market's enthusiasm. The prospect of an extra supply of equity has been known to unnerve investors. The authorities last month reversed an implicit ban on new issues and approved IPOs on the Shenzhen stock exchange for three small companies, including Guilin Sanjin Pharmaceutical, a traditional medicine maker. The retail portion of Guilin's listing was 584 times subscribed, which indicated continuing strong liquidity in the market, analysts said. "There are two factors that underlie the rally in Shanghai's stock market: one is optimism about economic recovery, and the other is available liquidity," said Chen Wen Zhao, stock market analyst at China Merchants Securities in Shanghai. Jing Ulrich, head of China equities for JPMorgan, said: "The pace of the A share recovery has taken everyone by surprise." She has revised her A share target to 3,200 by the end of the year, up from 3,000. "There's been a remarkable recovery in confidence. Is it tangible or is it not? That is very difficult to say." Some analysts are questioning whether the market could soon enter bubble territory. Wei Jianing, a senior researcher at the development and research centre of China's state council, or cabinet, was quoted in the official press warning that a large part of China's wave of new bank lending was being channelled into the stock and property markets. "The current model of bank lending can easily create new asset price bubbles - and has shown some signs of doing so," he was reported to have said by the Shanghai Securities News. Chris Peng, an investment analyst in Shanghai, questions whether it is fair to suggest the mainland equity markets are too exuberant. "If a bubble is defined as the market being much higher than average, then at the moment the price to earnings ratio is still lower than the 15-year average calculated from 1994," he said. The current average price earnings ratio was about 30 against the 15-year average of 42. Mr Chen said: "No one can define exactly what a bubble is. Is 3,000 a bubble? Is 3,500? There is no fixed standard." He worries about whether China's economic recovery is sustainable. "Last year the economy was 500m below sea level and now it's 300m below. It is much better, but it is still below." Mr Peng said there were disparate views about what would happen next for equities. "Some believe there is still room to grow, whereas others believe the market needs adjustment." The Chinese government, for its part, seems to be confident that the market is strong enough to absorb its first mega-IPO since they were unofficially suspended last September. Reuters reported yesterday that Chinese regulators had given final approval to Sichuan Expressway to raise at least Rmb1.4bn in Shanghai in the near future. How the markets digest an issue of that size may determine whether Shanghai enjoys a second half of the year anywhere near as good as the first.