China’s Small-Cap Stocks Enter Bear Market on Slowdown

China’s small-company stocks fell, dragging the benchmark index down more than 20 percent from its February peak, on concern valuations are too high as the economy slows and new share offerings divert funds.

The ChiNext index dropped 2.2 percent to 1,226.47 at the close in Shenzhen, entering a bear market after tumbling 21 percent from a record high of 1,558.62 on Feb. 17. The Shanghai Composite Index slid 5.5 percent during the period. Bocom International Holdings Co. and UBS AG predict further losses for the ChiNext as a housing slump adds risks to an economy that analysts predict will grow at the slowest pace in 24 years.

The gauge rallied 163 percent from a low on Dec. 3, 2012, through its record on Feb. 17 as the government took steps to boost technology and services industries while curbing the role of state-owned companies. The ChiNext still trades at 53 times reported profits, down from a record 74 times in September and compared with 9.9 for the Shanghai index.

“Small-caps have pretty big room for further declines as valuations far outpace earnings growth,” said Wang Weijun, a strategist at Zheshang Securities in Shanghai. “Big caps will perform relatively well and they may already have been in the bottom thanks to low valuations.”

China’s large-company shares rose today as gains for consumer-discretionary companies overshadowed losses for technology stocks. The Shanghai Composite added 0.1 percent to 2,026.50. The CSI 300 Index climbed 0.1 percent to 2,145.95.

Small-cap shares are falling globally as investors flee stocks with higher valuations. In the U.S., the Russell 2000 Index is hovering near the first 10 percent decline since 2012, while the MSCI All-Country World Small Cap Index has dropped 4.5 percent from its March 6 record.

‘Minsky Moment’

Chinese President Xi Jinping said last week that the nation needs to adapt to a “new normal” in the pace of economic growth. New building construction fell 22 percent in the first four months of the year, while home sales slid 18 percent in April. Data on industrial output, retail sales and investment for April released this week all trailed analysts’ estimates. A report today showed foreign-direct investment in China rose 3.4 percent last month to $8.7 billion.

China’s economy is far from a “Minsky Moment,” the China Securities Journal reported today, a term used to explain an asset collapse following the exhaustion of credit expansion.

The moment is very likely to happen when bank credit to corporations reaches about 250 percent of the country’s gross domestic product, the paper said. The ratio for China was 140 percent in 2013, it said.

Bad Loans

Nonperforming loans rose by 54 billion yuan ($8.7 billion) in the three months through March to 646.1 billion yuan, the highest level since September 2008, according to data released by the China Banking Regulatory Commission yesterday. Bad loans accounted for 1.04 percent of total lending, up from 1 percent three months earlier.

Beijing Originwater Technology Co., the biggest company in the ChiNext, fell 4.1 percent today, while Huayi Brothers Media Corp., the third largest, slumped 3 percent to the lowest level since August. Huayi Brothers, whose film “Journey to the West: Conquering the Demons,” generated the most revenue among domestic films in 2013, has rallied 190 percent since the start of last year.

“The ChiNext market has gone a bit too far and valuations are stretched,” said Wu Kan, a fund manager at Shanghai-based Dragon Life Insurance Co., which oversees about $3.3 billion. “It needs a big correction before it comes back.”

Bocom Forecast

The ChiNext was created in 2009 as an alternative for smaller companies seeking to raise funds and has fewer listing requirements than the two main boards in Shanghai and Shenzhen.

Suzhou Electrical Apparatus Science Academy Co. is the worst performer on the ChiNext this year with a 42 percent retreat. Zhangjiagang Furui Special Equipment Co., which makes metallic pressure vessels, has slumped 38 percent for the second-biggest drop.

The small-cap gauge may drop a further 7 percent to 8 percent, Chen Li, UBS’s chief China equity strategist, said in a May 13 interview. A 10 percent drop would be a buying opportunity, he said.

The China Securities Regulatory Commission re-convened meetings of its listing committee in April, signaling initial public offerings will resume soon after a halt since January. A total 336 companies have released IPO prospectuses on the regulator’s website as of yesterday.

“A small-caps correction is far from over,” Hao Hong, the Hong Kong-based chief China equity strategist at Bocom, said in an e-mailed response to questions on May 14.

— With assistance by Shidong Zhang

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