China equities: Stock market fever

Sun Shuming could barely contain his joy. With one hand holding aloft a glass of champagne and the other making a thumbs-up sign, Mr Sun beamed as a bank of cameramen snapped away on the floor of the Hong Kong stock exchange. Shares in GF Securities, the brokerage he runs, had just jumped 40 per cent within moments of going public on Friday morning.

The debut of GF Securities could not have been better timed, coming at the end of a week of record trading in Hong Kong. The sudden arrival of billions of dollars from mainland Chinese investors pushed the market to its highest in more than seven years, while volumes on the exchange smashed all records.

On Thursday, the value of trades on the Hong Kong market was more than double the combined figure for London, Frankfurt and Paris. So much capital flowed into the city that its monetary authority was forced to intervene to protect its currency peg to the US dollar.

Brokers like GF Securities have been among the biggest beneficiaries of the surge. Haitong rose almost 40 per cent in just a week, while Citic Securities, China's biggest broker, is up a quarter. The market capitalisation of Hong Kong Exchanges & Clearing, the stock market operator, has grown by a third to $36bn, making it the world's largest exchange.

The week's frenetic activity could be just a taste of things to come, since Chinese retail investors are only now making their first forays into international markets. And they have brought something with them from home - stock market fever.

Li Shengnan, a 33-year-old sales associate for a consumer goods company in Shanghai, called a friend last week seeking investment advice. Ms Li wanted to know whether to take out a mortgage on her apartment and use the funds to invest in China's red-hot equity market.

"I never played the market before, but since March it seems like my friends and co-workers are all getting rich, so I got excited," she said.

After years of poor performance, confidence in the stock market has returned in China with a vengeance. Savers have switched hundreds of billions of dollars out of property, deposits and wealth management products in the hope of making a fast buck in stocks.

A rally that began in July last year pushed the Shanghai index above 4,000 on Friday for the first time since early 2008. The market has now gained 68 per cent over the past six months. "The equity market is back as a genuine force in the minds of Chinese savers," Westpac Bank wrote in a note.

However, signs of a bubble are emerging. Investors opened more than 4.8m new stock trading accounts in March alone and almost 1m more in the first two days of April, according to the latest figures from the country's main clearing house. These accounts largely represent new investors like Ms Li entering the market for the first time.

The explosive growth of margin lending, in which brokerages lend money to investors to play the markets, also suggests irrational exuberance. Margin loans outstanding in Shanghai and Shenzhen - home to China's two stock exchanges - totalled Rmb2.2tn ($358bn) on Wednesday, two-and-a-half times the total six months earlier.

"We see a lot of people who don't understand stocks and don't know how to judge risk rushing in," said Hou Anyang, investment director at Front Sea Asset Management, a Shenzhen-based hedge fund. "We're worried about it, but there's nothing to be done. Every investment cycle is like this. It's the small investors who get hurt."

The previous market cycle was particularly painful for retail investors. In October 2007, the Shanghai Composite soared to an all-time high of 6,124 points, having more than tripled in value over the previous year. Within 12 months, the index tumbled to near 1,800, leaving retail speculators nursing their wounds for the next seven years.

The backdrop for this rally is far different. China's economy expanded at its slowest pace in 24 years in 2014, but investors still saw a case for buying Chinese stocks: valuations in Shanghai trailed far behind those in the US, Europe and Japan.

Now, however, the market looks like less of a bargain. The Shanghai Composite, dominated by state-owned banks and energy companies, trades at around 15 times forward earnings, double from the 7.5 times last summer.

Far frothier valuations can be found in China's booming tech sector. Beijing's drive to shift the economy away from smokestack industries towards innovation and services has convinced investors that tech companies are poised for growth. China's Nasdaq-style start-up board, ChiNext, now trades at 49 times forward earnings, more than double the 21-times valuation of the Nasdaq. According to Bloomberg research, valuations in China are higher than at the peak of the US dotcom bubble.

Technology is just one of several popular stock "concepts" - investment themes that brokerages use to drive investor interest.

Others are tied to government policy initiatives such as "One Road, One Belt", the government's ambitious plan to stoke foreign demand for its industrial output by financing infrastructure investment around Asia. The 21st century Maritime Silk Road and a land-based counterpart, the Silk Road Economic Belt, are expected to drive sales to Chinese trainmakers, port operators and electricity producers.

Another popular theme is the reform of state-owned enterprise, which dominate industries like finance, energy and telecommunications, but whose returns trail far behind privately owned rivals.

Two state-owned train manufacturers, CSR Corp and CNR Corp, have emerged as darlings for both these concepts. These companies have seen their Shanghai-listed shares more than triple since the start of 2015, and now trade above 50 times earnings.

Despite signs of a bubble, analysts and investors expect the China share rally to continue, at least in the short term. They also distinguish between large-cap stocks like banks, whose valuations remain comparable to global peers, and speculation-driven tech stocks.

"Some of the valuations definitely aren't reasonable, but if you look at asset allocation, yields in the equity market are still higher than bonds or real estate, so I think this rally has farther to run," said an equity trader at a top-five brokerage in Shanghai. Confidence also stems from central bank policies aimed at propping up the economy. The People's Bank of China has cut benchmark interest rates twice since November and reduced the share of customer deposits that lenders must hold in reserve at the central bank.

Such loosening has drawn comparisons to the US stock market in 2010 and 2011, when loose money fuelled big market gains, even as the real economy remained sluggish.

This week, China's equity fervour finally spilled beyond its borders. With stocks in China reaching a 35 per cent premium to those trading in Hong Kong, market veterans say mainland investors are simply switching into cheaper listings. "The pressure cooker in China has built up," says Tim Franks, head of hedge fund sales at HSBC. "This is a way of releasing that pressure from the system."

Some see Beijing's hand at work. An article in a state-run newspaper appeared this week under the headline "Go! Buy Hong Kong stocks!", while the decision to allow mutual funds to invest in Hong Kong has been credited as the trigger for this week's jump in trading. The influx of Chinese cash has been made possible by the launch in November of a trading scheme known as the Shanghai-Hong Kong Stock Connect. The link gives global funds much freer access to Shanghai stocks and allows mainland investors unprecedented access to shares in Hong Kong.

Until this week, they had largely chosen not to, instead focusing their attentions on Shanghai and Shenzhen. But on Wednesday, when the market reopened after a public holiday, the daily Rmb10.5bn quota for Chinese purchases of Hong Kong stocks was exhausted for the first time. The same thing happened on Thursday, pushing trading volumes to $37bn - more than three times last year's average.

"I don't even have to think too much when I trade these days as almost every stock is rising," said a Hong Kong-based trader at a leading asset management company. "Now it's our time."

The question now is whether this is a blip or the start of a new era. HKEx executives are already talking about boosting the daily quota to allow more Chinese money to flow in. "There's plenty of time, plenty of opportunity and plenty of money to make," said Charles Li, chief executive of HKEx. "The party's going to be here to stay."

Additional reporting by Julie Zhu and Ma Nan

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