As China Stocks Outrun the 2007 Bubble, UBS Braces for Clampdown

With China’s world-beating stock market attracting an unprecedented number of novice traders, the question on many investors’ minds is how long authorities will let the rally run before stepping in to cool things down.

As UBS Group AG strategist Lu Wenjie sees it, policy makers may add to existing interventions as soon as later this year. The Shanghai Composite Index’s 121 percent surge over the past 15 months isn’t justified by earnings prospects in an economy growing at the slowest pace since 2009, according to Lu.

“It’s absolutely possible we’ll see some draconian measures from the regulators,” he said in an interview in Hong Kong. “The pace of stock rally is too fast.”

While authorities have already placed curbs on margin trading and made it easier for short sellers to wager that stocks will fall, the measures have so far done little to slow the Shanghai Composite’s ascent to a seven-year high. The gauge posted an average peak-to-trough retreat of 28 percent after six previous rounds of policy intervention to curtail stock speculation since 1996, according to Bank of America Corp.

As the attached charts show, the current Chinese equity boom is outpacing the surge from a low in 2005 that culminated in the 2007 bubble. Returns are bigger than at the same stage of that rally, while new-account openings and a measure of momentum are higher. Valuation multiples and trading values are both jumping at a faster pace.

The Shanghai Composite rose 0.4 percent to a seven-year high on Thursday even after a Chinese manufacturing gauge fell to a 12-month low in April. Here’s what the market indicators show now versus a decade ago:

*Shanghai Composite performance: The index has rallied 121 percent from its low on Jan. 20, 2014, compared with a 77 percent advance in the 15 months ended Oct. 11, 2006.

*Stock accounts: New trading accounts have surged more than 18-fold to 1.68 million in the week ended April 10, the last reading before regulators ended a rule limiting individual investors to just one account. They increased 167 percent through Sept. 29, 2006 to around 31,000.

*Relative-strength index: The Shanghai Composite’s 14-day measure of share-price momentum has climbed to 80.1, above the 70-level that indicates to some traders that prices are poised to fall for a 26th straight day. It was 75.7 nine years ago.

*Valuations: The price-to-earnings ratio of the Shanghai gauge has more than doubled from its low to 21.7 times earnings. That compares with an increase of 44 percent to 23.7 a decade ago.

*Turnover: The value of shares changing hands on the Shanghai Composite Index has surged about 18-fold to 862 billion yuan ($139 billion). In 2006, trading rose three-fold to 24 billion yuan.

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