Chinese shares are looking decidedly frothy

At the start of last year, Chinese stocks were cheap and only 200 were valued highly enough - had they been American - to have qualified for the blue-chip S&P 500 index. Today, Chinese stocks are (very) expensive, and 482 are worth more than the smallest US blue-chip.

Among them is Beijing Baofeng Technology, which has produced perhaps the wackiest share price performance in history. In 33 trading days since its float in Shenzhen, it has risen by the daily maximum on 32 of them, for a 2,827 per cent gain on no news.

In the process, Baofeng has gone from a sub-$200m small cap to a valuation of more than $4bn, equivalent to America's 494th-placed company and almost as large as US Steel. It makes a video player, and, at least last year, not much money: it is valued at 494 times last year's earnings.

Baofeng is merely the frothiest of what looks increasingly like a "babyccino" market: like the children's version of a cappuccino, China's market is still missing the crucial ingredient for the eventual caffeine jolt: profits.

The bubbles are particularly extreme in Shenzhen, and in technology: the median tech stock traded in the city is priced at 65 times forward earnings (the median Nasdaq tech stock is at 19 times). There are exceptions. Banks, which make up more of the Shanghai market, are still priced for bad news. Still, Longview Economics calculates that large state-owned enterprises have performed very similarly to large completely private companies in the CSI 300 index over the past year.

There is some logic amid the fizz. Shenzhen-listed companies' profits are forecast to grow a little slower than US biotechs, and are priced a little lower.

But those who look for logic are probably wasting their time. Following the latest widely-predicted rate cut, one in eight Shenzhen stocks leapt by the 10 per cent daily limit, as did one in 12 of Shanghai's. Logic was present: tech stocks, with profits in the distant future, benefit most from a lower discount rate, and their shares led the way up.

In reality, though, easier money means more leverage for punters, which means higher prices only as long as the froth lasts. As the chart shows, the last bubble lasted a very long time indeed. Sip with care.

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