The Shanghai Composite Index rebounded quickly Thursday after losing over 5 percent in intraday trading. It closed with a 0.76 percent gain at 4,947 points.
The rise was mainly underpinned by the financial sector, and corrections in other sectors have yet to be completed.
Banking plays outperformed on Thursday amid mounting speculation about reforms encouraging mixed ownership of state-run banks.
Bank of Communications (601328.CN) hit the daily 10 percent limit, while China Everbright Bank (601818.CN), Industrial Bank (601166.CN), Bank of China (601988.CN), China Merchants Bank (600036.CN) and China Construction Bank (601939.CN) posted rises of between 4 and 9 percent.
There were in fact no major headwinds Thursday that could cause the market to slump 5.35 percent at its lowest point.
The slide was mainly due to psychological factors: most investors were looking to take their profits as the benchmark approached 5,000 points.
And the market started to panic, which led to a further drop.
However, massive bottom-hunting capital entered the market when the index had fallen over 5 percent and pushed it back to the upside.
An obvious headwind might be the failure of A shares to be included in the MSCI Emerging Markets Index.
Morgan Stanley said that while this may not happen next week, the A shares are very likely to be included in the influential index within the next 12 months.
There are divided views on whether A shares are too expensive.
Some optimistic investors believe there is still huge upside, as the government is set to unveil further stimulus measures. So, they say, earnings and other fundamentals are not that important.
However, investors might look for an opportunity to take profit when most stocks have hit a record high.
And company earnings will be closely watched.
Stocks that have poor earnings will suffer a sell-off in the near term.
CITIC Securities predicts that mainland-listed companies will post earnings contractions, as monetary easing measures have yet to affect the real economy.
The median price-earnings ratio of the 571 stocks covered by Shanghai-Hong Kong Stock Connect has already hit 74.5 times, and only 58 of the stocks have a P/E ratio of less than 20 times, representing only about 10 percent of the total.
Most of these lower P/E stocks are banking or insurance plays, as well as some big state-owned enterprises, such as Kweichow Moutai Co. (600519.CN) and Great Wall Motor (601633.CN).
However, there are 177 companies on the stock link list that have P/E ratios over 100, accounting for 31 percent of the total.
The A shares appear to be not cheap at all at such prices.
And investors will face increasing risks if they totally ignore fundamentals.
In fact, the market rally has largely been driven by liquidity over the last few months. And it may continue as long as the capital stays.
The Shanghai and Shenzhen markets had a combined turnover of 2 trillion yuan (US$320 billion) Thursday.
Beijing will continue to support the equity market to bolster the real economy.
Investors should accumulate undervalued financial plays, such as bank and insurance stocks.
This article appeared in the Hong Kong Economic Journal on June 5.
Translation by Julie Zhu
– Contact us at [email protected]