global markets freeze, fret and fall, there is an island of bullish sentiment way out east. Welcome to China’s stock market, 75 per cent up on the year, which is building historical highs on an almost daily basis while the rest of the world watches America’s subprime troubles and sells off.
China’s market has come a long way in a short time. From kerb trading on the back streets of Shanghai in 1984, the market’s official capitalisation is now $2,700bn. It has been one of the world’s best-performing markets over the past 12 months. Average prices are some 50 times historical earnings, with a number of companies having price/earnings ratios of more than 1,000. Risk aversion? There is no easy Mandarin translation.
One is tempted to write this bullish sentiment off as unsustainable exuberance that will fade once fundamentals reassert themselves. The truth is more complicated. Massive liquidity – and wealth – have been accumulated in China over the past two decades and it is currently locked up in mainland equities and real estate. In less than five years that wealth is going to flood out of the country, causing huge tremors in overseas asset markets.
The future did not always look thus. During 2002-04 China’s stock market looked sick, crippled by slow profit growth, hundreds of scandals and concerns over the huge overhang of state-owned shares, which investors worried might one day flood the market. The Shanghai composite briefly fell below 1,000 and many thought its pulse would stop soon afterwards. In recent days, however, the index has exceeded 4,800; 5,000 looks reachable and some boosters are looking for 8,000 before the Beijing Olympics kicks off in August 2008.
To some this looks like a bubble. In May, Beijing hit the market with a series of measures, including an increase in the trading tax, to damp sentiment and prevent a bigger bubble. But those half-hearted measures were no match for corporate profit growth, low interest rates and all that liquidity.
Today’s boom has its roots in China’s financial history. Even before 2004, the amount of money sloshing around China’s economy (and stored under beds) was massive relative to the scale of goods and services produced. By 2004 the ratio of M2, the broad indicator of money supply, to gross domestic product had reached 160 per cent, much higher than in most other economies. China had got to this point by stimulating its economy in slow times, by either massive bank lending or budgetary stimulus packages. In recent years, more liquidity has been imported via huge trade surpluses (running at $20bn a month), plus foreign investment and “hot” money inflows.
The People’s Bank of China, the central bank, has kept much of this liquidity at bay via sterilisation operations, but pressures are immense and interest rates remain suppressed. In 2003, these funds began to slosh into property and then, in mid-2006, into equities, monetising them. But this will change in the next three to five years as China’s wealth gets more adventurous and starts to travel. Many routes for taking out funds have been opened up already. The mainland’s high-net-worth investors are active in the H-share market in Hong Kong and QDII, the scheme where retail investors give their money to banks to manage offshore, is becoming more popular. The all-but-certain appreciation of the renminbi keeps the wealth locked up at home.
But given a 5 per cent or so appreciation each year, the renminbi will soon become more fairly valued. China’s household and corporate wealth becoming footloose presages an important change. We are all familiar with one of the effects of a globalising China: the relative price of labour falls, meaning cheaper “stuff”. The second-round effect will be very different. As China’s wealth globalises, the relative price of assets bought by private China is going to rise. Residential land in Hong Kong and Vancouver, farmland in Africa and natural resources in Asia will bear the first brunt of these outflows. The second wave could be companies with big and successful operations in China itself, where local consumers are witnessing the successful growth of many global companies themselves.
The “China price” will no longer be the cheapest world price for a commodity. It will be the hefty premium paid for assets in which private China has invested. Do not think about the Shanghai stock exchange as an anomaly. Think about it as the future.
The writer is Standard Chartered Bank’s senior economist in Shanghai, and author of China’s Stock Market