24 October 2016
Mainland stock investors may have reason to be cheerful for several months more. Photo: Xinhua
Mainland stock investors may have reason to be cheerful for several months more. Photo: Xinhua

Why A shares are likely to peak by end of the year

I predicted late last year that the mainland stock market benchmark was likely to surpass 5,000 points this year. That came true in less than six months.

However, the market has slumped as much as 13.3 percent after hovering above 5,000 points for less than two weeks.

Will the market run-up wind up?

If not, how much further upside is there, and what should investors do?

The pace of the market rally and the excitement of market participants are very similar to what we saw in the super bull market in 2007.

If we compare the two recent bull cycles, the market followed a very similar bear-to-bull track after peaking in June 2001 and July 2009.

The Shanghai Composite Index plunged after those peaks. The bear cycle lasted for about five years.

This time, the market rally can be sustained for five months more if the bull cycle lasts as long as in 2006-2007.

Meanwhile, China’s economic growth remains weak, and exports to its four largest trading partners have expanded at the lowest rate since the financial crisis.

The Chinese central bank is eager to buoy up the equity market in an attempt to stimulate economic growth. However, the efforts have yet to pay off.

The market rally is poised to continue given that Beijing is determined to support the stock market.

Also, the Shanghai Composite Index has jumped more than 60 percent this year, and it’s quite natural to see a correction of over 10 percent.

A shares are no longer cheap from a valuation perspective.

The ratio of the total market cap of the Shanghai and Shenzhen markets to gross domestic product has already exceeded the historical median and even surpassed the 2009 peak.

Although the ratio still falls short of its level during in 2007 bull cycle, it remains questionable whether A shares will climb as high as they did then, as company earnings and the performance of the economy are less vibrant.

So, the mainland market is likely to reach its peak in the last quarter of this year, and the bull cycle may also wind up late this year, as valuations may become extremely stretched by then.

This article appeared in the Hong Kong Economic Journal on June 25.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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