Super-bull on the rampage

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“BULL market” does not adequately describe the frenzied buying of Chinese shares in the past two weeks, so local media have started calling it a “super-bull”. China’s stockmarket has surged 21% in the last ten trading days, and that is building on a 20% rally over the previous four months. One of the world’s worst performers for three consecutive years, China has suddenly shot to the top of the table for all major markets in 2014. The rally has also propelled China ahead of Japan as the world’s second-biggest equity market by value, with a total capitalisation of more than $4.5 trillion.

There are plenty of plausible, but partial, explanations for the boom. The central bank has switched to looser monetary policy, injecting at least a trillion yuan ($163 billion) of cash in the economy this year and cutting interest rates for the first time since 2012. A new trading link between the Hong Kong and Shanghai exchanges has, for the first time ever, allowed any foreigner to access China’s onshore market, albeit with some restrictions. A property downturn and a regulatory crackdown on financial firms offering high-yield investments have left domestic investors searching for new frontiers; the long-suffering stockmarket beckoned. What’s more, Chinese shares look relatively cheap after their long, bad run.

Yet almost all these things have been true for some time. The massive gains of the past two weeks have the air of “mania taking hold”, as Mark Williams of Capital Economics put it. It is reminiscent of an even giddier climb in 2006-7, which ended in a crash (see chart 1). Television newscasts and business newspapers are full of excited reports; pensioners crowd into stockbrokers’ offices to swap their savings for shares; online chat-rooms buzz with advice about which stocks to pick. Wild intra-day swings in the market have been driven by sentiment rather than anything fundamental. On Friday, the Shanghai Composite, the country’s biggest index, jumped nearly 3% after opening and then slid again, falling 3%. It see-sawed for the rest of the day and closed up 1.4%. Trading volume reached a record $104 billion, more than three times higher than the 100-day average.

There is no question who is behind the boom: retail investors. Individuals account for about 80% of trading in China, massively outweighing institutional investors–the opposite of more established markets. After losing money for years, China’s mom-and-pop investors had all but turned their back on equities. The recent rally has brought them back in a big way, pushing the market to new heights. Last week they opened 370,000 new trading accounts, the most in three years (see chart 2).

Your correspondent visited a Shanghai branch of Qilu Securities, a brokerage, on Friday to take in the action. Some brokerages still provide trading rooms to their clients, lined with computer terminals for them to use. As the market has taken off, scenes from these rooms, packed with retirees, have featured on the evening news. But the Qilu branch was one of the modern breed of brokerages, offering just one terminal and primarily serving clients with online accounts.

One middle-aged man, Mr Xu, had come to meet a manager to inquire about how to subscribe to initial public offerings; their average first-day gain has been about 40% this year. He said he had taken the afternoon off work for the meeting and could hardly conceal his glee. “I’ve been trading since 1992 (just two years after the Shanghai Stock Exchange was established) and I guarantee you this bull market will last,” he said. He confessed to getting badly bruised by the last big one – his portfolio of 500,000 yuan had swollen to 3 million yuan by 2007 at the peak of the market, before falling back to its original level.

At the other end of the spectrum in terms of experience was Ms Zhou, 25, an interior designer with dyed-blonde hair. Like many other young professionals, she had previously put a big chunk of her savings in an online investment fund marketed by Alibaba, an e-commerce company. The fall in interest rates has reduced the return on that fund, pushing her to look for alternatives. “I had been thinking for a while about buying stocks but I had to travel for work and missed the best opportunity,” she sighed. “I will be conservative at first. Just one or two thousand yuan. Or maybe ten thousand.”

It all seems a bit like irrational exuberance, but both international and historic comparisons suggest that it might not be so irrational after all. The Shanghai index is currently trading at 10 times expected 2015 earnings, compared with 15 for the MSCI world index, an average of developed markets. Shanghai is also inexpensive by its own standards. Jonathan Garner of Morgan Stanley, an analyst who had predicted a bull run in China months ago, says the market’s trailing price-to earnings ratio of 14 is a 35% discount to its 10-year average.

There are, however, troubling signs. Leverage has played a far bigger part in this rally than any before it because of the introduction of margin financing, which allows investors to buy shares with borrowed money. Outstanding margin positions in the Chinese market have doubled to more than 800 billion yuan since July, according to Chen Long of Gavekal Dragonomics. The stock rally is predicated on the idea that interest rates will continue to fall, but a sell-off in bonds has driven debt yields up this week, and some hedge funds believe the equity boom might lead the central bank to delay further easing. Still, for most investors, greed is trumping fear for the time being. One of the top headlines on financial websites on Friday was a quote from an investors’ call hosted by Guotai Junan, a brokerage: “Buying shares in financial companies is buying the China dream.”

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