Mainland market rally looks ominously like 2007 bubble

PUBLISHED : Tuesday, 28 July, 2009, 12:00am
UPDATED : Tuesday, 28 July, 2009, 12:00am

It's almost like old times again.

Back in May 2007, the South China Morning Post warned readers that a bubble was inflating in the mainland stock market.

At the time, the Shanghai Composite Index had risen 100 per cent over six months and the market was looking increasingly frothy. Initial public offerings would frequently double in value on their first day of trading, and the market as a whole was priced at an inflated value of about 30 times expected earnings for the year.

Even so, undismayed by the steep valuations, hundreds of thousands of punters a week were opening new stock trading accounts in anticipation of making equally spectacular gains over the following months.

'No one can doubt any longer that we are witnessing a genuine stock market bubble,' we warned, adding, however, that it could easily be many months yet until the bubble finally burst.

In fact, it was another six months. The market topped out in early November before tumbling 72 per cent over the next year.

Today, that fall is largely forgotten, and the market feels a lot like it did in May 2007. Yesterday, the Shanghai index closed at 3,435.212, up more than 100 per cent from the low in November last year (see the first chart below). Meanwhile, on its mainland trading debut, Sichuan Expressway, the Shanghai market's newest flotation, opened at more than double its issue price, and then doubled again before being suspended.

At 26 times expected earnings for the year, the Shanghai market is now looking decidedly pricey, while at 32 times, Shenzhen stocks are even more expensive (see the second chart).

Still, that hasn't stopped investors pouring money into shares. In the second week of July alone, more than 480,000 opened new brokerage accounts. Once again, it looks like a speculative bubble is inflating in the mainland's stock market.

It's clear enough why. At the end of last year, the central government ordered China's banks to pump up their lending to support economic growth in the face of an export slump.

The banks complied with enthusiasm. In the first six months of this year, they extended an astonishing 7.37 trillion yuan (HK$8.36 trillion) in new loans. To put that sum into perspective, it's more than the entire economic output of Australia last year. More to the point, it's equal to a massive 56 per cent of China's own gross domestic product for the first half of this year.

With companies suffering from overcapacity and stalling sales, many hesitated to invest their borrowings in business expansion. As a result, a significant amount of the borrowed cash found its way into the stock market. According to one official's estimate, about 20 per cent of this year's new loans, or almost 1.5 trillion yuan, have been channelled into the mainland's asset markets.

The influx of funds pushed share prices higher, catching the attention of local retail investors. With domestic three-month time deposits paying a miserly 1.71 per cent interest rate, many soon began pumping money into the stock market again, fuelling a powerful momentum-driven rally.

That's making monetary officials nervous. In recent days, central bankers have talked repeatedly of reining in loan growth and warned banks to vet borrowers more carefully.

Yet, with senior government officials from Premier Wen Jiabao downwards insisting on the need to maintain a 'moderately loose' monetary policy to support economic growth, there is little chance of any significant monetary tightening before the end of the year at the earliest.

So although it looks very much as if a dangerous bubble is inflating in mainland stock prices, it's highly likely that prices can go on rising for a long time yet before the bust comes - just like they did in May 2007.




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