Speculative fever is alive and well in China. As I write, locals are piling into the rising Chinese stock market – the best performing market in the world over the past six months. More than ten million new stock accounts have been opened this year, greater than the combined total for all of 2012 and 2013.
This new found enthusiasm for stocks is mainly because locals are finding it difficult to earn a decent return on their savings – the real estate market is in decline, funds on deposits offer little and currency controls prevent them from investing abroad.
Shares on the two main exchanges, Shanghai and Shenzhen, have almost doubled in value over the last six months and valuations have now risen to more than 30 times forward earnings, with some companies exceeding multiples of 100 times. These valuations make US companies look cheap – the median company in the US Standard & Poor’s 500 index trades at 18 times its future earnings. There is no doubt that Chinese companies have good prospects but it is difficult to argue these justify a price earnings multiple almost double that of US companies.
Perversely, while valuations are rising, the general economy appears to be slowing down and there are concerns over the real estate market. However, the recent signs of economic slowdown have only encouraged investors, as they bet on the State seeking to boost the economy through a combination of stimulus packages and looser monetary policy.
Even the Chinese authorities are concerned about this rapid advance. The state-run Xinhua News Agency recently warned of â€œirrational exuberanceâ€ in the market. It is clear alarm bells are ringing and it is particularly worrying that many investors are using borrowings to fund their investments – the proportion of Chinese stocks bought on borrowed cash has increased roughly eightfold since 2013.
Can all these new investors do well? Unfortunately, history is against such a favourable outcome as markets have a nasty habit of reversing when investors are most heavily involved. Furthermore, where investments are financed through borrowings, any market reversal can be dramatic, as investors are forced to sell in a falling market, exacerbating any decline.
The prospects for Asian markets generally are still attractive but China seems to have temporarily got ahead of itself. In the circumstances, I would caution against being overly exposed to China and would be inclined to focus more on other Far Eastern markets.