24 October 2016
Tim Craighead (inset) warns of historical volatility in the Shanghai Composite Index. Photos: Bloomberg
Tim Craighead (inset) warns of historical volatility in the Shanghai Composite Index. Photos: Bloomberg

Understand China’s sharp stock spikes, beware of retracements

Several factors are propelling China’s stocks to new heights.

The People’s Bank of China cut interest rates, and Shanghai-Hong Kong Stock Connect has opened mainland stocks to global flows.

Momentum-driven retail investors in mainland China have opened record numbers of new accounts, and low bond yields and declining property prices offer few alternative investment opportunities.

In the meantime, many China indexes have risen more than 80 percent since September.

Looking at the history of rallies in Chinese stocks may be enlightening.

The Shanghai Composite Index has had two extended declines of more than 40 percent since 2001, along with six shorter spikes ranging from 24 percent to more than 450 percent.

This market behavior may partly reflect a large retail investor base that aggressively pursues short-term trends.

Even with the stock surge, price-to-earnings ratios for most Chinese stocks are still below levels reached in past peaks.

The Shanghai Composite is trading at 15.8 times, compared with a 2009 peak of 23 times, while the MSCI China H Index of Chinese stocks listed in Hong Kong is valued at 12.2 times estimated earnings, versus 15.5 times.

Reforms and stimulus will help determine the rally’s sustainability versus a history of short-term spikes and long-term retreats.

Recent reforms encouraging insurance and pension growth along with greater market access for global and local investors could alter the volatile market dynamics over time.

The views expressed in this article are those of Tim Craighead, director of Asian research and senior gaming analyst at Bloomberg Intelligence.

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