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A shares: a resting bull or a bursting bubble?
(chinadaily.com.cn)
Updated: 2007-02-09 17:29
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The Chinese domestic stock market is stabilizing after last week's sell-off amid policymakers' concerns over a stock market "bubble". Regulators seem to be backing off from their tough rhetoric that has spooked investors. As investor anxiety begins to fade, it is time to reflect on the fundamentals:
Are ChineseA sharesin a dangerous bubble that is about to burst, or is the recent shakeout just a classic bull market correction preceding a series of new highs in prices? What is the appropriate investment strategy for the near term and beyond? BCA Research makes the following arguments:
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With a trailing price-to-earnings (P/E) ratio of 30, A shares are not cheap. In fact, they are arguably expensive, especially when compared to other Asian markets. However, it is premature to conclude that the A share market is in a dangerously inflated bubble.
Current valuation indicators of Chinese domestic stocks (P/E at around 30) are nowhere near the heights reached during previous financial manias around the world, or China's own speculative bubbles in the early 1990s (P/E at over 90).
Furthermore, Chinese stocks are not overly expensive when the ultra low interest rates are taken into account. Currently, the earnings yield on stocks is 3.3 percent, compared to a 2.5 percent savings deposit rate and a 2.9 percent government bond yield.
As a rule of thumb, a country's equity market should roughly reflect nominal economic growth. The annual compound rate of returns for the A share market has averaged 15.3 percent since 1992, roughly on par with the average nominaleconomic growth rateof 14.7 percent over the same period. The top panel of Chart 2 shows that the domestic market stands at almost exactly the same point as suggested by the country's nominal output level.
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