Yesterday I attended a seminar on what to expect of the Chinese economy and stock market in the coming year. Lucky to know, I wasn't the most pessimistic one there. There was a lot of talk about the bullish Chinese economy, the overheated stock and futures markets, and the Olympics. Oh what an interesting year 2008 will turn out to be for China. Here I will outline what I learnt yesterday, or what I knew already and found people agreeing with me on.
1. Chinese stocks are overpriced by a large margin, larger than you would like to think. Approximately a month ago, I would say that Chinese stocks on average had a P/E ratio of 60. That's pretty high, considering stocks in the US only had an average multiple of less than 20 in times of boom. But that's not the end of the story. This is because most of the listed Chinese companies have no clear business plan - they don't know where to invest their profits in, so they invest in each other's stocks, but this fact is rarely shown publicly. So in essence, the P/E ratio on average should be higher, and it is, on average at 100.
2. In August 2005, Chinese stock indices hit rock bottom. Earnings from listed companies were level and not sky-rocketing as we are accustomed to nowadays. So why did everything seem to grow from that point on without looking back? I quote:
"China's stock market has been in the doldrums for almost five years despite occasional spurts of speculative activity. The benchmark Shanghai Composite Index, which tracks both yuan-dominated A shares and foreign currency B shares, closed at 1,161 points at the end of 2005, down from 2,242 points in mid-2001. Daily turnover of A and B shares on the Shanghai bourse declined to an average of 8 billion yuan (US$1 billion) at the end of 2005, down more than a quarter from the previous year.
The overhang of massive blocks of government-owned shares in the listed State-owned enterprises was responsible for much of the decline, as major shareholders remained indifferent to price fluctuations of stocks and, consequently, stock transactions and capital allocation were hindered. The combined value of these so-called "non-tradable" shares at current market prices amounted to an estimated US$280 billion, or more than two-thirds of the total market capitalization."
Non-tradable shares were to blame. But in August 2005, the Chinese government laxed a set of regulations that allowed more than 400 state-owned enterprises to divest their non-tradable shares...slowly, so that the Chinese stock market won't be sent into a tailspin. The key to all this is timing. The reform program, for most companies, were set in a way such that every year, more and more non-tradable shares became floatable. About 20% of such shares came onto the market every August. Come August 2007, the time when our glorious Beijing Olympics is just about to wrap up, more than 96% of all shares of all listed Chinese companies will be tradable. Think about that.
3. Why am I sure that holders of previously non-tradable shares will sell at that point? It's hardly a question of game theory. it's partly to do with "fake earnings." When shares were still non-tradable, the top management had incentive to keep earnings high. How they did this many not be righteous, but many listed state-owned companies had even more privately held state-owned companies. With a little movement of resources counted as earnings, given the high P/E ratio, price shoots up higher than the value of the resources going in.
After top management has sold their previously non-tradable shares in the aftermath of the Olympics, they will have no incentive to pump up their earnings anymore. A big sell-off and lower "real" earnings should send the market driving down. Nevertheless, the Chinese economy won't lose steam because many of these companies rely on all sorts of other funding. But if you think stocks are heading downwards after the Olympics, you may be right for the wrong reasons.
What is your personal forecast for the Chinese stock market?
.jpg)
Comment Preview