Talk of a Chinese Equity Bubble is All Relative

Hickey and Walters (Bespoke) submit: With the Shanghai Stock Exchange Index eclipsing yet another millennial mark over the last week, it seems as though there has been a pickup in the number of articles calling China's stock market a bubble with out of control valuations.

While we have already made the comparison of China's market now to the Nasdaq in the late 1990s, another comparison between the two indices shows that China's 'Bubble' may not be so large after all. Comparing the current valuations of both markets shows that the trailing P/E ratio for the Shanghai Stock Exchange is 42.63 with a dividend yield of 0.5%. The Nasdaq is not much cheaper. Its trailing P/E ratio is 38.32 with a dividend yield of 0.6%, and until late April, it had a higher P/E ratio.

If we add in the growth rate of each market's underlying economy, we see that China has much faster growth, which justifies some sort of premium to the slow growing US economy. According to the most recent data, China grew at an 11.1% rate, while growth in the US was a more paltry 2.1%. While it is nearly impossible for someone to make the argument that China is cheap at current levels, the mere fact that is has gone up so much so fast is not in itself enough to warrant the 'Bubble' tag.

Comments

[huangjin:]

How about the fact that Chinese earnings are selling at a 40% discount?

2007 May 14 04:00 PM

[Annon Hong:]

Sure everything can be made less significant by comparing to more extreme cases. But do we really want to overlook the fact that China has many of its major infrastructures in early development stage and that we should just compare its economical data in such an isolated way? Is it really just the index and dividend numbers that matter in determining whether it is a bubble or not?

2007 May 14 04:39 PM

[JW:]

why don't you compare the shanghai index with Taiwan & Korean index back to 15-20yrs ago. US compare doesn't really ring the bell when it comes to the reality of economic boost you just mentioned in your chart.

2007 May 14 06:46 PM

[Daniel Su:]

I have not seen any Chinese company was penalized for accounting irregularities, except there was one steel company announced the deal with Angola goverment which later turn out to be extra ordinary exaggeration. Is that mean Chinese accountants/auditors, or accounting system are better than US?, or lack of supervision?

2007 May 14 07:16 PM

[huangthomas:]

Don't forget China has a closed capital market. Since Chinese are not allowed to invest outside of their border, except for recent approval of QDII to invest $~10 bn in foreign markets. They can only look at their markets. Any comparison with "foreign markets" is meaningless to Chinese detail investors, whose 5-year CDs are paid annual interest rate of 2.8% by their government. They are forced to make a choise between CD and Chinese stock market. There are no other channels of investment. Real estate market is already to expensive and beyond reach of great majority of Chinese.

Let go back to 1999, Shanghai stock index is ~2,400 and the P/E is higher than today, index at ~4,000. There was no Western-style bubble-burst in year 2000, simply they didn't have high tech industry then. There were major dips, partly caused by government policy, which was fixed in 2004. The stock market start to take off in 2005 associated with a torid growth in national economy. This indicates to me that in a rapidly developing & closed capital market, Chinese investors can accept or tolerate a high P/E ratio.

If we always look at snario in China through Western glasses, you can never understand China. Rapid increase in detail investment account is of major concern, but not their P/Es.

It is funny that when American shouting bubbles, the typical Chinese response is "what bubble?". Their reaction is as intelligent as American reaction to Greenspan's "irrational exuberance" warning in 1996. We all remember our reaction: "It's different this time!".

2007 May 15 11:27 AM