The A-share market is set to step into a massive bubble phase if authorities continue to stay on the sidelines. This could trigger a real disaster economically and politically.
At this stage, a “vicious cycle” would emerge, as asset prices, the economic climate and company earnings push against each other upward, and stock and property prices are also on the rise.
This translates into a spiraling effect, which will push up asset prices, rents, property prices and wages. As we arrive at the end of the bubble, the so-called herd behavior will incentivize more people to apply more leverage to push asset prices to crazier levels.
Many Chinese stocks are fairly cheap, a fact that some investors have ignored. For example, the P/E ratio of Industrial and Commercial Bank of China has been below 6, while its dividend payout ratio reached 6 percent. The stock is clearly undervalued.
The P/E ratio of other banks is around 6 to 7, although their dividend payout may be less generous. Such an attractive valuation has resulted from market fears about shadow banking, which is unlikely to blow out in the next 12 months.
I have recommended to a relative to buy A shares of ICBC at 4.2 yuan per share, and China Merchants Bank at around 13 yuan.
Actually, it’s not hard to find bargains in the A-share market with promising earnings outlook. The P/E ratio of Vanke is only 9. Investors should look for any hidden traps in terms of P/E, dividend payout ratio, and P/B ratio.
It’s a mistake to compare the current level of 3,000 points with an overly undervalued level of around 2,000 in the past. If you start at such a low point, you would make a mistake in evaluating the current and future stock price.
Some investors are holding back as they think the current level is “too high”, or they just want to take profit and get out.
This kind of mentality explains why the Shanghai Composite Index has been consolidating at the key level of 3,000 points. However, the comparable basis will be lifted if the index continues to march to 4,000 and even break past 5,000.
Also, the bull market may feed itself if the A shares continue their rally for a few months. This would change people’s mindset and expectations. More people would jump into the stock market. And those who are already in the market would borrow more, use retirement savings or even company capital to increase their positions.
This kind of behavior would drive up stock prices, draw more investors into the market and trigger more leveraging, which in turn would further push up stock prices and inflate the bubble.
The A-share market is still in the early stage of bubble-making, which means the multi-month price rally would trigger a set of changing market behavior and expectations.
Translation by Julie Zhu
This article appeared in the Hong Kong Economic Journal on Wednesday.
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