Why BofA’s Global Bond Guru Is Fixated on Chinese Equities

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Forget U.S. Treasuries and the euro.

If Bank of America Corp. is right, the new must-watch indicator for global bond and currency markets comes from somewhere few traders in New York and London would think to check: the Shanghai Composite Index of Chinese share prices.

“Normally, when I come into the office, the first thing I look at is where 10-year Treasury yields are trading, where euro-dollar is trading,” David Woo, the head of global rates and currencies research at Bank of America, said in an interview on Bloomberg Radio in New York. “These days, the first thing I look at on the Bloomberg terminal is where the Shanghai Composite is trading.”

Woo said China’s rally has become so big -- he called it the world’s largest bubble since dot-com boom of the late 1990s -- that the eventual collapse will have consequences for markets around the world.

Chinese shares may drop as much as 30 percent when the mania ends, weighing on consumers who have been an important driver of growth in Asia’s largest economy, Woo said. He expects the selloff will be bullish for the dollar and U.S. Treasuries.

It will have a “knock on effect on the whole world economy,” Woo said. “The only thing that’s holding up the Chinese economy are the Chinese consumers right now. The Chinese consumers are all involved in the Chinese stock market.”

Bubble Valuations

Shares on mainland exchanges trade at an average of about 264 times reported earnings after a 141 percent rally in the Shanghai Composite over the past 12 months. The median stock has a ratio of 101, while the Shanghai Composite, which has a heavy weighting toward low-priced bank shares, was valued at 25 times as of Wednesday.

Fueled by monetary stimulus and record inflows from amateur investors, the index climbed to a seven-year high this month. It sank 3.7 percent at the close in Shanghai on Thursday, while the Bloomberg Dollar Spot Index slipped 0.1 percent and Treasuries gained.

When the Nasdaq Composite Index peaked in March 2000, technology companies in the U.S. had a mean price-to-earnings ratio of 156. It took the Standard & Poor’s 500 Index about seven years to recover from the aftermath of the dot-com bubble, while the Nasdaq gauge reclaimed its high only this year.

Woo joins analysts from Bocom International Holdings Co. and Macquarie Investment Management in saying Chinese stocks are overvalued. A market crash may come within six months, Bocom said Tuesday, citing an analysis of global bubbles over 800 years.

The build-up of leverage in Chinese shares resembles that of the U.S. housing market in 2008, Woo said. Margin debt on mainland exchanges climbed to a record 2.24 trillion yuan ($361 billion) on June 16.

“In 2008, the leverage was in U.S. housing as a result of five years of easy monetary policy,” Woo said. “This time around, after five years of easy monetary policy, the bubble is now sitting in China, where the leverage is.”


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