No Bounds for China's Stock Frenzy

The government's efforts to dampen demand have done little to slow the momentum of mainland markets, as the CSI 300 index has soared 185% this year

Chinese investors have taken irrational exuberance to entirely new levels. On Oct. 15, the Shanghai Stock Index blasted through the 6000-point mark, and closed at 6337 on Oct. 17, up an astonishing 125% since the beginning of the year. The broader CSI 300 index of the top Shanghai- and Shenzhen-listed companies is up 185% and shows no signs of slowing. "It's totally out of control," says Carl Walter, a managing director at JPMorgan (JPM) in Beijing who co-authored a book, titled Privatizing China, about mainland stock markets.

Government officials are worried. Shang Fulin, chairman of the China Securities Regulatory Commission, raised the alert during a panel discussion at the 17th National Congress of the Communist Party in Beijing this week. "I want to express my concern over the lack of risk awareness among investors," Shang was quoted as saying by the official China Daily newspaper on Oct. 17. His sentiments were echoed by People's Bank of China Governor Zhou Xiaochuan, the paper reported. Yet this official jawboning has done nothing to temper investor ardor.

The government's attempts to dampen demand through five interest rate hikes this year have done little to slow the market momentum. One reason: Real interest rates remain negative as inflation picks up speed. The yield on one-year time deposits is 3.87%, below price inflation, which grew 4.1% during the first nine months of this year and is accelerating. Prices jumped 6.5% in August and are projected to have risen more than 6% in September. Official September inflation figures are expected on Oct 23.

Greater Acceptance of Higher Multiples

Ironically, a move by the government aimed at siphoning off some of the liquidity in Chinese markets is actually helping fuel optimism. In late August, the State Administration of Foreign Exchange announced a pilot scheme that would allow mainland retail investors to buy shares in Hong Kong stocks.

That unleashed a wave of buying in Hong Kong from local and overseas investors in anticipation of strong Chinese demand for mainland companies with listings in Hong Kong, whose shares have usually traded at a considerable discount to their mainland-listed counterparts because of the restrictions on investment. The prices of Hong Kong-listed H-shares have since soared, narrowing the gap in price-earnings valuations between China- and Hong Kong-traded shares of the same companies.

This in turn has made mainland investors more willing to accept ever higher p-e valuations in Shanghai and Shenzhen, based on the belief that Hong Kong prices will rise to meet those on the mainland rather than mainland prices falling to meet Hong Kong's. Price-earnings multiples now stand at an average of 65 times 2007 earnings. "This makes A-share investors even more fearless," says Frank Gong, chief China economist at JPMorgan Securities (Asia Pacific).

Chinese Not Following Buffett

Meanwhile, the white-hot initial public offering market with its eye-popping first-day returns continues to draw ever more money into the market. On Oct. 9, for example, China Shenhua Energy, the country's biggest coal producer, soared 87% on its first day of trading in a Shanghai IPO that raised $8.9 billion (BusinessWeek, 10/15/07).

All eyes are looking forward to the Shanghai IPO of Beijing-based PetroChina (PTR), expected to raise more than $5 billion in November. On Oct. 16, the oil giant overtook General Electric (GE) to become the second-largest public company in the world by market capitalization, behind Exxon Mobil (XOM). As of Oct. 17, NYSE- and Hong Kong-listed PetroChina was valued at $434 billion, while GE closed at $418 billion on Oct. 16.

But even U.S. billionaire Warren Buffett's belief that it's time to take some money off the table with Chinese stocks is unlikely to deter mainland punters from piling in. Though Berkshire Hathaway (BRKA) has sold more than half of its stake in PetroChina this year and plans to liquidate its entire holding, the market euphoria among mainland investors will likely ensure PetroChina's Shanghai IPO makes a spectacular debut.

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