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Photographer: Andreas Rentz

Asian Stocks Get All Bubbly

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It's only April, but 2015 already seems to be the year of the Asian stock bubble. In addition to mainland China's bubbly markets, the region is dealing with two other equity booms that don't jibe with economic fundamentals.

In Hong Kong, gains are racing well ahead of global rallies even as China's slowdown accelerates. Mainland companies listed in the city jumped another 4.3 percent Monday, even after news of an unexpected 14.6 percent plunge in Chinese exports in March. The Hang Seng Index -- which grew 7.9 percent last week -- has also been unaffected by the mainland's sputtering real estate market. And something similar is happening with Japan's Nikkei market. The country's economy is limping out of a recession, and Bank of Japan officials have been bracing for disappointing inflation numbers. Yet the stock market is trading near 20,000 for the first time in 15 years.

This isn't something for either country to celebrate. In the absence of solid growth, these stock market rallies are only being propped up by government action and the expectation that there will be more of it.

You could make an argument that stocks in Hong Kong are attractive on the basis of price-to-earnings ratios -- shares are trading at an 11.8 percent multiple in Hong Kong versus 15.8 percent in New York, 20 percent in Shanghai and 52 percent in Seoul. But there's little reason to believe investors have suddenly grown bullish on Hong Kong companies. They've mostly been pouring money into little-known mainland companies whose valuations in Hong Kong are much lower than in China -- in other words, they're mostly in it for arbitrage opportunities.

The government in Beijing has encouraged this gold rush in two ways. First, officials have used stock markets to help funnel investors out of the overheated mainland property market, on the theory that surging stocks would improve confidence in China's broader economy. The Communist Party has initiated PR campaigns to encourage investors to make the shift and offered them sweeteners like lower trading fees and less red tape. Tens of thousands of Chinese investors have recently opened trading accounts.

Initially, their activity was focused on mainland stock markets. But as trading activity showed signs of irrational exuberance in Shanghai and Shenzhen -- up 27 percent and 55 percent so far this year, respectively -- the government tried to export its asset bubble to Hong Kong by expanding the Shanghai-Hong Kong Stock Connect, a trading scheme that facilitates cross-border investments. Now so much money is flowing Hong Kong's way that local authorities have been forced to intervene to defend the currency's peg to the U.S. dollar.

This can't end well. Hong Kong has long been an anomaly in the greater China region, because its stock market has been reasonably transparent, and stock prices and valuations have traditionally been based on the careful decisions of educated investors. Now Hong Kong's stock market is skewing in ways that resemble China's irrational corporate landscape. And Hong Kong's bubble will probably be the first to pop: Investors who are in a rush to reduce holdings in China will likely prefer to sell in Hong Kong, where the currency is fully convertible and there are transparent legal regulations for such transactions.

Japan's rally, which resembles the heady days of the 1980s, is also "government-made," according to economist Yasunari Ueno at Mizuho Securities. In addition to the BOJ's record quantitative easing efforts -- including a pledge beginning last October to purchase $700 billion of government debt annually -- Tokyo is nudging the managers of the $1.1 trillion Government Pension Investment Fund to buy shares on the Nikkei. As in China, the hope is that surging valuations will improve confidence more broadly in the economy.

That theory hasn't seemed to work in practice: Japanese corporate executives and middle class households continue to express doubts about the country's economic trajectory. If anything, investors in Japan and China mostly seem to be acting on the belief that weak economic data will spur the government to inject even more easy money into the economy and the stock market.

Of course, that could prove a trap for both countries. Stock bubbles will always be in need of further reinforcement. And the more time Beijing and Tokyo spend manipulating stocks, the less officials will be doing to implement overdue structural reforms.

Asia's bubbles won't necessarily crash this year. With compliant central banks and vast savings, China and Japan can probably marshal the resources to keep the party going for a while. But Asia's two biggest economies are now on a treadmill that will be increasingly difficult to get off of.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Willie Pesek at wpesek@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net