Share prices in China have taken on a life of their own

China's stockmarkets

Rush hour
Oct 4th 2007 | HONG KONG
From The Economist print edition




TRAFFIC jams were not only to be found on the streets of Hong Kong this week. Share-trading systems were also clogged up as investors piled in after a holiday to mark the founding of the People's Republic of China. Mainland markets were closed for the Golden Week, which only seemed to drive more money to Hong Kong. On October 2nd the Hang Seng index closed above 28,000 for the first time, rising 3.9% in one day. Shares of mainland Chinese firms climbed even higher amid talk of heavy buying by institutions in China able to invest in Hong Kong.

A day later prices eased, but the gossip didn't. There were rumours that the Hong Kong stockmarket would attract some of the new $200 billion sovereign-wealth fund created by China's government. An announcement in August that ordinary Chinese would be allowed to invest in Hong Kong has also raised hopes of still more money to come. In China, most industries are caught up in the excitement, but in Hong Kong, shares of mainland firms trade at a discount to those in their home markets. That means arbitrage opportunities abound.

The bull market should make life sweet for securities analysts—at times, too sweet. Citigroup, for example, put a strong buy recommendation on China Resources Land, a property company, in mid-September, saying the share price could appreciate by 20%. Two weeks later, it had. Next big idea?

What if there are none? Certainly at some point rational price-earning assumptions will suggest there is nothing left to buy. Shares on the Chinese bourses have jumped to almost 65 times historic earnings from the 50s a week ago (see chart). Yet there is something suspiciously circular about the valuations because many firms profit from investing in shares. Future expectations, meanwhile, are staggering. The Hong Kong stock exchange trades at 39 times book. The ten-year average is six times.

Even the Chinese government is worried. To cool the markets down, it has imposed transaction taxes and higher interest rates. The management of the Shenzhen Stock Exchange has tried to talk the market down—to no avail. Officials should instead promote better disclosure so that investors can find out what they are buying. Transparency, however, is sensitive in China. Some assume that the Chinese government has too much at stake to let the market fail: the upcoming party congress, for example, or stable conditions ahead of the 2008 Olympics. Foreigners appear to buy that argument. Flow-of-funds data from Citigroup show that they continue to pour money in. Perhaps they think it is crazy to miss out on the madness.