After China's A-share markets rocketed 130 per cent over the first nine and a half months of this year, only to slump back 15 per cent in the past 10 weeks, working out what is likely to happen to mainland stock markets next year is one of the most challenging tasks in the business. There are good reasons to argue that the Shanghai and Shenzhen markets are dangerously over-inflated bubbles that are fully primed to burst next year with messy and painful consequences. Equally there are rational grounds for predicting that the bull market will simply run out of steam and that stock prices will tail off sideways, neither rising nor falling substantially from their current levels. Finally there are strong reasons to believe that the bull market is only pausing for breath and that it will recover its vigour next year, pushing mainland indices upward to newer and ever greater highs in the coming year. Whichever scenario turns out to be correct, however, one prediction is likely to prove accurate: by the second half of next year, mainland stocks are likely to look like much better value investments than they do today. And strangely, that is still likely to be the case even if prices resume their climb in the new year. The argument that the bubble is ready to burst is simple enough. Since its 2005 low, the Shanghai Composite Index has risen five times over (see chart). That run-up has carried valuations into fantastic territory. Shanghai-listed shares now trade at price to earnings ratios of around 50 times; close to levels they reached immediately before the bursting of the last mainland stock market bubble in 2002. Now as then, there are ominous signs that investor enthusiasm for equities is waning. Recent initial public offerings have flopped in the after-market, most noticeably for oil giant PetroChina. Meanwhile, the number of new individual investment accounts opened each week has dropped to around 150,000, from almost 400,000 in the second quarter of this year. And daily trading volumes have plummeted. Moreover, things may be about to get much worse. As the government continues to tighten monetary policy in an attempt to rein in inflation, some analysts are beginning to worry that companies' core earnings could start to suffer. On top of that, a further slide in the stock market could erase corporate earnings - which are estimated to have accounted for a quarter of profit growth this year - from equity investment. That would severely dent investor sentiment, potentially pushing the market into freefall. But that is a worst case scenario. Whatever happens to the stock market, underlying earnings are likely to continue to grow at 25 to 30 per cent in the coming year, propelled by China's double digit economic growth and rapid improvements in productivity. And there is a strong argument that the recent sell-off is only a temporary hiatus in a longer-term bull market. With the interest paid on bank deposits rates still below the consumer inflation rate, despite recent rate hikes, there remains a strong incentive for savers to shift money from their bank accounts to the stock market. Analysts at UBS note that the free-float of China's stock markets is worth only about 10 per cent of the country's financial wealth, compared with an average of around 30 per cent for the rest of Asia, implying there is a great deal more money likely to flow into equities in the future. Meanwhile, analysts at Macquarie point out that although the recent gains in mainland markets look big, they pale in comparison to the 2,000 per cent rise in Taiwanese equities between 1982 and 1990 (see chart). On that basis China's bull market has barely begun. Whichever of these scenarios proves correct in the short term, one thing that is likely is that the valuations will begin to look more reasonable into next year. Strong underlying earnings growth means that if markets fall or move sideways, price to earnings valuations will fall over the coming months. And even if markets continue to gain, the recent cooling in investors' frenzy, tighter liquidity and an increased supply of new stock coming to market will mean gains are likely to be more moderate than in this year. In that case, according to analysts at investment firm Roth Capital Partners, even if the Shanghai composite climbs another 80 per cent reaching 9,000 in 2009, price to earnings ratios will decline from current levels. It seems that whatever happens next year - barring a headlong resumption of collective mania - Chinese stocks are likely to look better value in the future.