How high does China’s stock rocket go?

Cross-posted from Investing in Chinese Stocks.
Chinese are starting to ask how long the bull can last. Most brokerages had 4000 as the high for 2015, it has already been achieved. Investors are also concerned about a bull market erupting amid an economic slowdown, iFeng A股仅用9个月实现翻倍 本轮牛市能走多远:

Many investors doubt “in the context of the economic downturn, why would form a bull market,” which is why some of the more up market investors do not mind more at ease in the root of that fear of heights, early selling missed the bull feast.

4000 stock index last Friday stand-point mark, it is worth noting that 4000 was the beginning of many brokerage agency predicted in 2015 the “top.”

Rushed 4,000 points, A shares “casino” theory of speech has become popular. Critics on “A bubble were many?”, “A bull market can actually carry long?”, “China’s stock market irrational exuberance to the limit it?” And discuss triggering hot, some investors also increased fears.

Guotai Junan raised its target to 4600 and sees the third stage of the rally unfolding:

Guotai JunanPublished research reported that the bull market is about to enter the third stage. This stage, the mood will seek to promote the capital market depression, blue chip mature and grow, market-style reflected the “new equilibrium.” Based on this judgment, the increase of the Shanghai Composite Index to 4600 points target, while raising the GEM index near the 3000 target. And the bull market in 2007 compared to the fundamental differences between this bull market is that the driving force quit the macro and micro driving force to start. And after the third stage of the bull market’s performance will depend on the macroeconomic drivers of gradual recovery, and the risk-free rate decline could launch a new round.

Haitong Securities notes that no bull market ever peaked with the PPI at a low:

Haitong Securities chief economist Lee Thunder observed A shares bull markets you will find this rule: When you start, PPI and CPI are relatively low, the government adopted a policy to cut interest rates, as in May 1996, December 2008 and November 2014. When the 2006-2007 bull market that round starts, PPI is in a relatively low, relatively high point at the end. In the exchange since its establishment 25 years, there has not been the case of the bull market peaking with a negative PPI and no signs of recovery. From this perspective, to achieve economic recovery will take time.

He thinks the bull market will go on longer than expected.

Meanwhile, from Bloomberg, China Walks $264 Billion Tightrope as Margin Debt Powers Stocks:

Confident that China’s stock market rally still has legs, Jiang Lin recently began borrowing money from her brokerage to buy more shares.

Her newly-opened margin finance account with state-owned China Investment Securities Co. has allowed Jiang, a 29-year-old marketing executive in Beijing, to double up her bets on the vertigo-inducing rally in Chinese share prices.

“It’s worth the risk,” said Jiang, while admitting she doesn’t fully understand how margin finance works because she hasn’t had her broker explain it to her.

Margin debt is double the size of the U.S. market:

China’s margin finance now stands at about double the amount outstanding on the New York Stock Exchange, after adjusting for the relative size of the two markets.

“Regulators are aware of the risk of rising margin debt but they can’t afford to puncture the equities bubble with very draconian measures,” said Lu Wenjie, a Shanghai-based analyst at UBS Securities Co. “They want to pelt the mice without smashing the china.”

More insanity:

The authorities may also be tempted to hold off because stock valuations remain lower than levels before past market collapses. The Shanghai Composite is at about 20 times reported earnings, or less than half of the level it reached during a 2007 rally.

Because the prior crashes were so much fun. In defense of the authorities: there’s no way to really stop a mania unless you permanently change the rules on margin and find ways to ban other forms of credit leaking into the market. How likely is that in China?

There’s more:

The bans on Citic, the nation’s biggest brokerage, Haitong and Guotai Junan expire on Thursday, leaving the firms free to seek new clients again. They have the capacity to do so, said Zheng Chunming, a Shanghai-based analyst at Capital Securities Corp. He calculates that Chinese brokerages can boost margin loans to as much as 2 trillion yuan if they raise their capital and leverage ratios to regulatory ceilings.

Another 25% increase in margin is potentially on the way.

And from Citi via FTAlpahaville:

From an Asian portfolio perspective we’ve been over weight China since the middle of last year. We can’t say that owning China has been a pleasure on a daily basis but as of late, it has been a rather more pleasurable experience. During the time that we’ve owned China there have been times where investors have questioned our sanity rather vocally whilst others have been polite enough to sit through our rational. With the China market is doing rather well as of late, investors have been more on the listening side but still not quite on the “buying side”. The buyers you see have tended to be retail rather than institutional which, if you are bearish is then yet another reason as to why staying bearish is viewed as the right course of action. We continue to disagree and remain overweight China within both an Asian and EM portfolio and here is why…

Our approach is rather simple. Within either the Asian or EM benchmark we seek to buy markets which are cheap (defined as low P/E, P/CE, P/BV, P/S and DY) vs others and have better momentum (defined as EPS revisions and price momentum) vs the other markets in the universe… So where does China sit? China sits in the attractive quadrant.

The momentum is good, we all know this, and the market isn’t exactly expensive. So, when investors tell us that China is a bubble and expensive all we need to do is highlight that a market which is very certainly an investor favourite, India. This market is even more expensive relative to all the other markets and it isn’t as if investor after investor we meet tells us, “oh boy that Indian market is hotter than your average Vindaloo.”

So how expensive is the Chinese market? In Figure 1 we highlight the valuations based on implied EPS growth rates to perpetuity. The markets in EM with the highest implied EPS growth rates to perpetuity India (6.5%), Poland (6.4%), South Africa (6.3%), Indonesia (6.2%) and then the Philippines (6%).

Out of these five markets, three, from all the data we can get, are also consensus overweights. Indiamore on that later, Indonesia and the Philippines. Now, let’s look at the other end of the distribution, the cheap markets. Russia (- 2.4%), Singapore (0.6%), Korea (0.8%) then China at 1.1% and then Taiwan at 1.3%. Amongst those five guess what four are consensus underweights-Singapore isn’t part of EM but within an Asia context it too is an underweight. So from that perspective it is hard to make a case that China is an expensive market.

The same is also true if one uses simple P/E’s, P/BV, P/CE or even dividend yield see Figure 2 and all along China continues to generate a higher ROE. And yes, if we remove all the cheap stocks from the China universe, the market will be more expensive. But then if we removed all the China doubters, China would be India! Yes, China still has value absolute and vs many others in EM…

Whilst some like to talk about stock market bubbles when it comes to China, valuations show this not to be the case as yet. For a simple bubble test, see Figure 5, the Asian P/BV from 1975 to the present day, once we reach 2.7 times P/BV by all means reach for the rip cord and pull it hard. Had you done so repeatedly over the last 40 years it would have saved you a fair amount of bother and made you a fair amount of money. At present Asia is on 1.5 times book. Keep the bubbles in the fridge it is too early to celebrate.