China's equity bubble is building, may burst

Updated: 2007-05-07 10:30

Investors talk at a securities brokerage firm in Shanghai April 27, 2007. [newsphoto]

China's all-time high equity market needs "cool water and cool heads" after taking a 7-day Golden Week breather, otherwise the stock bubble runs the danger of a quick bust, experts said.

Since its nine-percent correction in late February, the Shanghai A-share equities have now moved back up more than 40 percent, and no letup is seen on the horizon, buoyed by a series of successful initial public offerings as the ranks of investors swell at over 200,000 a day. There are now more than 91 million accounts held at brokers or mutual funds.

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Xia Bing, director of the State Council's Development and Research Center's Finance Department, warned at a recent CCTV talk show program, that the stock market bubble is building. He and a string of other economists suggested investors take extra caution before jumping onto the bandwagon.

And, analysts at BCA Research put it in a recent note to its customers: "We have no doubt if China's market continues to spike up, the stage will be set for a very violent drop."

In late April, the People's Bank of China ordered the ratio of commercial banks deposits at the central bank be raised to 11 percent, but the measure failed to dampen the bullish market. The surge has continued. Many economists are anticipating another interest rate hike in May or June to stonewall the soar.

Some critics argue the way the mainland IPO market is being run systematically fans the irrational expectations of a huge number of novice investors with the promise of easy and quick money, storing up trouble ahead.

It is widely believed that mainland investors are mostly momentum-driven and ignorant of valuations, but they can see the IPO market is serving up a bargain. While stocks in the A-share market trade at stiff premiums to Hong Kong, dual-listed equities often continue to list at a discount in the mainland.

The situation is due to the influence of the powerful China Securities Regulatory Commission (CSRC) which micromanages new listings, sets final pricing of IPOs and subsequent fund-raisings as well as deciding who gets to list, analysts said.

For example, Bank of Communications recently listed at 7-20% cheaper in Shanghai than in Hong Kong, following a similar practice for China Life Insurance and Ping An Insurance.

In most other competitive markets, pricing is a commercial compromise based on what companies think they can get and what investment banks think the market can take.

A standard move these days is for the CRSR to force companies to set a lower price on their IPOs in the hope of a strong stock market performance. This has undoubtedly contributed to the general market euphoria. The average price-to-earnings ratio of Shanghai and Shenzhen markets is now over 50.

In the absence of traditional measures to cool the market such as significantly raising interest rates, another solution the authorities, in the hope to achieve a stronger and more stable market, are eyeing to bolster the stock market is by adding more quality companies to soak up excess liquidity.

The authorities have inspired mainland companies to list on domestic bourses rather than Hong Kong's, it has further encouraged overseas quality companies, such as the venerable HSBC Holdings to list A-shares in the mainland.

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