Sharks circle on China's stock markets

The great white shark has to keep moving or it dies. Its breathing system relies on a constant churn of new water in order to keep the oxygen flowing.

The typical Chinese stock rally works in a similar way. If starved of fresh liquidity, it tends to choke. Should it lose momentum altogether, multiple organ failure could follow with alarming speed.

On Monday, Chinese equities gave a discernible wheeze, probably triggered by the regulator's latest attempt to cool margin lending by tightening the rules for a common way Chinese investors borrow to buy shares. The Shanghai market shed 1.6 per cent, while the Hang Seng China Enterprises index - Hong Kong listings of mainland companies - dropped 2.9 per cent.

To sceptics, China is in the middle of stock market bubble anyway. The Shanghai market has now doubled over the past 12 months, bringing it to its highest level since early 2008, even as the economy has sputtered. Valuations in some corners - notably technology and healthcare - have long since quit reality, with some trading well above 100 times earnings. Millions of ordinary folk are lining up outside their neighbourhood brokers to open their first accounts. The pop, surely, cannot be too far away.

That Monday's equity slide followed a weekend cut to the reserve requirement ratio by the central bank lends support to that view. If new money no longer does the trick, maybe something sinister is afoot.

However, this market rally has something going for it that previous bull runs have not - central government support. Just a week ago, China loosened rules to allow retail investors to have as many as 20 trading accounts, up from the previous cap of one, hardly an indication of weighty concern over frothy markets.

Global investors, who tend to be underweight China, may well see any pullback as an opportunity to get in. Unlike in Shanghai, valuations for Chinese shares in Hong Kong remain at just under 10 times forward earnings - only Russian shares come cheaper.

Undervalued, and likely to find plenty of further policy support, this particular fish is not ready for the grill just yet.

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