Bubble risk grows as China's stock boom defies gravity

 

What do a ketchup maker, a precious metal distributor and a medical device company have in common? They are the new poster kids of a boom in China's equity market - and a potential headache for policymakers, as valuations defy fundamentals.

Fuelled in part by cheap credit and a crackdown on shadow banking, mom and pop buyers - who make up about 60% of the Chinese equities investor base - have been snapping up shares in a rally that has seen the benchmark Shanghai stock index double in six months.

The surge comes even as annual economic growth in the world's second-largest economy slowed to a six-year low of 7% in the first quarter, hurt by a housing slump and a downturn in investment and manufacturing.

The rally has taken money managers by surprise and analysts are voicing concern that "bubble" markets are likely to force authorities to impose cooling measures.

"We think this is a bubble brewing in some counters, bearing in mind the disappointing economic backdrop," said Grace Tam, a markets strategist at JP Morgan Asset Management in Hong Kong. "Authorities may likely take measures if this rally continues."

Take Cofco Tunhe for example. A maker of speciality chemical products, it's share price has more than tripled over the past year and it now trades at a multiple of more than 900 times forward earnings.

Or Beijing Kingee Culture Development, a distributor of precious metals. Trading at a multiple of 138 times, the stock has more than doubled in the past month despite it having negative cash flows and an operating margin of just 2%.

Companies mentioned in this article did not respond to requests for comment.

Despite the frothiness in some counters, the broader market is in line with their 10-year averages, compared with some Asian markets such as India which are more than fairly valued and facing some investor fatigue.

China watchers said a crackdown on shadow banking and the tepid performance of the property sector - a favourite investment option - means more investors could continue plowing money into equities.

"The animal spirits among retail investors are well and truly out," said Sherwood Zhang, an Asia-focused portfolio manager at US- based Matthews Asia. 

Less than 6% of Chinese households invest in equities compared to an overwhelming two-thirds of wealth parked in the property sector, according to Gavekal Dragonomics.

To be sure, authorities are allowing some of the money flow into other markets such as Hong Kong to let off some steam domestically. On Wednesday, sources told Reuters that China might launch a trial scheme that would allow individuals into the Shanghai free trade zone to invest overseas.

The stocks rally has surprised many institutional investors, who are still underweight China. A survey of mutual funds with about $1 trillion of assets under management are underweight between 140-600 basis points relative to the benchmark, according to Goldman Sachs.

"Unless we see regulators coming out and trying to stamp this rally, we may see the markets going on further," said Zhang at Matthews Asia.