27 October 2016
Stock market valuations in China are out of sync with corporate earnings. Photo: CNSA
Stock market valuations in China are out of sync with corporate earnings. Photo: CNSA

Why the Chinese markets have become riskier

Chinese authorities have managed to utilize the market expectation for policy and economic growth outlook and enabled a bull run in the stock market in the last few months.

Macro-economic data presented a mixed picture recently. Fixed-assets investment rose by 11.4 percent during the first five months of this year, down 0.6 percentage point from the growth pace recorded in the first four months.

Private consumption, meanwhile, started to pick up thanks to a buoyant stock market. Retail sales in the nation increased 10.1 percent in May from the previous year, up 0.1 percentage point from the growth in April. And value-added industrial output was up 6.1 percent last month, marking the second straight month of upturn. This suggests that the government efforts have paid off.

Beijing is poised to unveil more measures to boost investment and growth. Officials from the National Development & Reform Commission have revealed that the government would roll out various measures, including stimulus for emerging industries, manufacturing, modern logistics and urban transportation.

In other steps, authorities will advance public-private partnership in public service projects. And the collaboration between state-owned banks and corporates will be enhanced to ensure funding for these projects.

Beijing is determined to transform the domestic equity markets, which would pave the way for high valuations. However, the current stock prices are extremely expensive based on the actual company earnings. Chinese bourses have seen the market capitalization surge by US$6.5 trillion over last twelve months, marking a pace even faster than that recorded during the US tech bubble at the end of the 90s.

The Shanghai Composite Index has soared nearly 160 percent from 2,000 points to above 5,100 points. One should bear in mind that the Dow Jones Industrial Average surged over 200 percent during five years before the market crash in 1929.

The P/E ratio of Chinese markets also touched the highest in five years, even as the earnings of Chinese-listed companies hit a six-year low. Given this situation, the red-hot market is very worrying.

Fund-raising activity has benefited from strong market confidence. Authorities have eased their grip over big listings in light of active sentiment for new shares. China National Nuclear Power raised 13.2 billion yuan recently, marking the largest IPO deal in the last five years.

And the hectic market sentiment has also lured some Chinese companies listed overseas to return to domestic market. As many as ten US-listed Chinese firms have announced plans for A-share listings so far this year, involving a total value of US$12.4 billion. 

Meanwhile, some company promoters have taken advantage of surging stock prices to take profit. Data shows that major shareholders of 723 listed companies have reduced their stake and cashed 154.5 billion yuan in May. And another 56.8 billion yuan of profit-taking took place in the first 10 days of June in Shanghai and Shenzhen markets.

As a result, the profit-taking of major shareholders in Shanghai and Shenzhen amounted to over 200 billion yuan since May, while additional purchases by key shareholders only reached 18 billion yuan in the same period.

The China Securities Regulatory Commission has required brokerages to cap their margin financing within their capital size, while outstanding margin financing is not allowed to reach over four times of their net capital. The move is likely to curb the overly-hot market sentiment in the short term and possibly lead to a correction.

This article appeared in the Hong Kong Economic Journal on June 15.

Translation by Julie Zhu 

[Chinese version中文版]

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a columnist at the Hong Kong Economic Journal

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