China Stock Bull Getting Older, But Won't Die

Former U.S. central banker Alan Greenspan has predicted a "dramatic contraction". France's securities regulator warned of a "brutal" pull-back. Even billionaire investor Warren Buffett says the market is too rich for him.

But almost two years into one of history's greatest bull runs, China's roaring stock market continues to defy forecasts of disaster by the financial world's leading lights.

With Shanghai's main index up five-fold since the start of 2006, and stock valuations sky-high, local fund managers and analysts agree the market will slow in coming months.

But they think there's still plenty of money to be made from stocks over the next year -- and that predictions of a crash of 20 or 30 percent are way off the mark.

"Pressure on the market has increased a lot so its rise will slow," says analyst Qian Qimin at Shenyin & Wangguo Securities, one of the biggest Chinese brokerages.

"But the market isn't reversing -- and a collapse just isn't going to happen."

Foreign investors hold under 2 percent of Chinese shares, so local players such as Shenyin & Wangguo -- as well as the Chinese government -- may have the last word.

Eight local analysts surveyed by Reuters this week predicted the index, which was at 5,633 points at midday on Thursday, would close this year around a median of about 6,000. All but one forecast a rise to about 8,000 by next June.

SUPPLY BALANCE

One risk for the market is any change to supply-demand conditions. New money entering the market has far exceeded the supply of new shares this year, but that ratio may deteriorate.

Issues of new equity, including IPOs and follow-on sales, are ballooning. They totalled $38 billion in the first eight months of 2007 against $8.5 billion a year earlier, and analysts think supply could exceed $100 billion in the year through August 2008.

Some new money will be diverted as China lets investors put funds overseas. The official Securities Times estimated such outflows could total over $130 billion in the next year.

But those sums are not huge for a Chinese market capitalized at $3.9 trillion. About $2.7 trillion has been added this year, without apparent strain on investors' resources.

Stock market capitalization has soared from about 40 to 125 percent of gross domestic product this year, and it cannot outgrow the economy indefinitely. But the U.S. ratio is about 120 percent -- and China's economy is expanding 11 percent annually.

Daily openings of new stock investment accounts are running above 300,000, down from levels above 500,000 earlier this year but far above last year's levels of under 50,000. That suggests there's plenty of new money available.

VALUATIONS

Bears point to valuations as evidence of a bubble that will soon burst. Chinese stocks are trading at nearly 45 times this year's forecast earnings, more than double Hong Kong's level.

But that isn't prohibitively high compared to levels seen during the take-offs of other Asian markets -- Taipei reached 70-plus ratios in 1990.

And the market looks less expensive considering analysts' forecasts of roughly 30 percent earnings growth in 2008, down from 50-60 percent this year but much faster than growth abroad.

Injections of lucrative assets into listed companies by their state parents improve the picture. The government is encouraging such injections to improve corporate efficiency.

SAIC Motor (600104.SS: Quote, Profile, Research) quadrupled its earnings this year by obtaining manufacturing ventures from its parent in a $2.4 billion deal. Many companies are working on similar plans.

So many valuations are, quite reasonably, based not on companies' current earnings power but on assets they are likely to have a year or two from now.

"The bull run is far from over. Rapid growth in the economy and corporate earnings offsets part of the pressure from high valuations," said Wu Haijun, an analyst at Power Pacific Corp. of Canada.

POLICY

The market's health ultimately depends on government policy, so some investors worry about signs Beijing wants to cool the asset markets.

Officials are warning investors about risks, and regulators have not approved a new domestic mutual fund since mid-September, an apparent effort to slow fresh fund flows into stocks.

Among potential further steps are more tightening of monetary policy, introduction of a capital gains tax and the sale of some state holdings in listed firms, which would increase supply.

The government will take care to avoid sinking the market, however.

Creating an equity culture among ordinary Chinese, and making the market a useful source of funds for companies, are two of Beijing's major achievements.

Chinese analysts believe Beijing wants to cool the market in order to protect these achievements, not destroy them. Its one harsh step this year -- a trading tax hike that sent stocks tumbling 20 percent -- was quickly followed by positive official propaganda and policies that restored the uptrend.

"It's true the government is trying to cool the market, but the purpose is to maintain stability, not push down shares," says economist Jin Dehun at Shanghai Securities and Futures Institute.

"The official cooling measures will only slow the bull run, not stop it."

($1=7.5 Yuan)

2008-03-17

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