The Shanghai Composite index which is the benchmark index of the Chinese economy has soared 147% in the last one year and 60% from year to date in 2015. The Shenzhen Stock Exchange Composite Index is up 190% on a year on year basis. The Nasdaq Composite which is the benchmark index in the US economy has risen 16% in the same time.
What is driving the rally for the benchmark indices in China? A key factor is that a lot of new wealth in China is constantly looking for an investment avenue to park their money. The real estate market in the Chinese economy was in a bubble when the Government interfered to drive down the speculation. The new wealth was heavily invested in the real estate market that led to the bubble in property prices. Speculative money then went on to chase the Initial Public Offerings (IPOs).
Beijing Baofeng Technology Co. Ltd. offers online audio and video entertainment services. The Company provides a movie player, game website, video download converter, and other network entertainment tools. The stock rose more than 2900% after it got listed on the exchange in the month of March 2015. Many Chinese investors have bought shares using borrowed money. The amount of margin financing, whereby investors borrow from brokers and put up extra collateral if the price moves against them, has more than quintupled over the past year to 2 trillion yuan (USD 325 billion).
Shenzhen-listed companies now trade at an average price to current earnings ratio of 72 times, up from 35 at the start of the year 2015. Of the top 10 stocks by weighting on the Shanghai Composite, only one has risen more than 25% this year. Agricultural Bank of China, the third-biggest stock on the index, is up just 2.7% while China Life has added only 1.5%. The top company on the index by market capitalisation, PetroChina, has gained 11%. Bulk of the money has flown into tech stocks or start-ups that have raised money in this year.
Most of the investments or for that matter speculative money is coming from the Retail investors in China. This comes despite regulators clamping down on margin requirements and leveraged buying.
China unveiled “Made in China 2025” its latest initiative to strengthen start-ups involved in digital technology, cleantech, biomedicine and robotics. Regulators have also lowered the financial requirements allowing tech start-ups to stage an IPO on exchanges. And other changes are making it easier for Hong Kong and international investors to invest in mainland stocks, and vice versa.
The People’s Bank of China cut its benchmark lending rates by 25 basis points to 5.1 % on May 10th 2015. It is the third reduction since November prompted by low growth and declining property prices. The Chinese economy expanded 7.0 % in the first quarter of 2015, down from a 7.3 % increase in the previous three-month period. It is the lowest growth rate since the March quarter of 2009, due to a slowdown in manufacturing and property investment. Annual inflation rate has been below 2 % since September 2014. The producer price index fell by 4.6 % in April 2015 and has been declining since March 2012.
There is a clear cut case of China’s stock market rallying way far ahead of its economic fundamentals and a correction looks most likely in the current scenario. The magnitude of the correction would be definitely significant but the timing of the correction is what the investors would find out in the near future.