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If You Are A Chinese Stock Market Investor, Do Not Look At This Chart

The bubble cries are getting louder when it comes to Chinese stocks which, thanks to a surge in liquidity and exorbitant leverage, are in the midst of a truly epic rally that has quite a few observers concerned. BNP for instance, recently described the situation as a “self-feeding domestic frenzy” before offering the following rather ominous assessment: 

“Margin purchases are now accounting for almost 20% of equities daily turnover which itself has soared to wholly unprecedented levels in another sign of self-feeding speculative frenzy. What happens next is clearly an ‘unknown-unknown’. By definition detached from fundamentals, speculative bubbles are inherently re-enforcing in the short-term and frequently last longer than expected. The longer they continue, however, the larger the eventual bursting.” 

There appears to be little doubt that this particular speculative bubble has indeed before “re-enforcing,” because as we showed last week, the pace at which Chinese investors are creating stock accounts has accelerated with nearly 1.7 million accounts created in the last week of March alone (up 50% from the previous week which itself saw a 58% spike from the week before). Compounding the problem is that many new market participants lack even a junior high-level education suggesting that they may not be adequately assessing the risk factors. As we put it: “We certainly don’t see what could go wrong here. Last month alone, a new investor base the size of Los Angeles — many of whom may be only semi-literate — piled into Chinese equities which have nearly doubled in the space of 8 months on the back of margin debt that can now be measured as a percentage of GDP and volatility is at a 5-year high. Everything should be fine.”

Given all of this, it’s not exactly surprising (although it is scary) that Chinese tech stocks appear to be more overvalued (at a shocking 220 times profits) than tech stocks were in the US leading up to the Nasdaq collapse. Here’s Bloomberg:

The world-beating surge in Chinese technology stocks is making the heady days of the dot-com bubble look tame by comparison.

 

The industry is leading gains in China’s $6.9 trillion stock market, sending valuations to an average 220 times reported profits, the most expensive level among global peers. When the Nasdaq Composite Index peaked in March 2000, technology companies in the U.S. had a mean price-to-earnings ratio of 156.

 

Like the rise of the Internet two decades ago, China’s technology shares are being fueled by a compelling story: the ruling Communist Party is promoting the industry to wean Asia’s biggest economy from its reliance on heavy manufacturing and property development. In an echo of the late 1990s, Chinese stocks are also gaining support from lower interest rates, a boom in initial public offerings and an influx of money from novice investors.

 

The good news is the technology sector makes up a smaller portion of China’s equity market than it did in the U.S. 15 years ago, limiting the potential fallout from a selloff. The bad news is that any reversal in the industry will saddle individual investors with losses and risk putting an end to the Shanghai Composite Index’s rally to a seven-year high.

 

“Chinese technology stocks do resemble the dot-com bubble,” Vincent Chan, the Hong Kong-based head of China research at Credit Suisse Group AG, Switzerland’s second-biggest bank, said in an interview on April 2. “Given stocks fell 50 to 70 percent when that bubble burst in 2000, these small-cap Chinese shares may face big corrections when this one deflates.”

...and a few more shocking statistics: 

Among global technology companies with a market value of at least $1 billion, all 50 of the top performers this year are from China. The sector has the highest valuations among 10 industry groups on mainland exchanges after the CSI 300

 

Technology Index climbed 69 percent in 2015 through Tuesday, more than three times faster than the broader measure.

 

The CSI 300 technology gauge fell 2.2 percent at the close, the most among all industries and its largest decline in almost two weeks. The broader index advanced 0.8 percent.

 

Technology companies have posted the biggest gains among Chinese IPOs during the past year, helped by a regulatory ceiling on valuations for new share sales. Beijing Tianli Mobile Service Integration Co. is the top performer among 147 offerings during the period after surging 1,871 percent from its offer price to trade at 379 times earnings.

 

Valuations in China are now higher than those in the U.S. at the height of the dot-com bubble just about any way you slice them. The average Chinese technology stock has a price-to-earnings ratio 41 percent above that of U.S. peers in 2000, while the median valuation is twice as expensive and the market capitalization-weighted average is 12 percent higher, according to data compiled by Bloomberg.

 

“It’s a bubble in the making,” Teng Bingsheng, an associate dean at the Cheung Kong Graduate School of Business in Beijing, said in an interview on Tuesday. “Valuations are extremely expensive.”

Topping it all off, it now appears as though China’s bubble is set to spill over into Hong Kong thanks to the kind of stretched mainland valuations described above. As we reported earlier: “China's Shanghai Composite briefly rose above 4000 for the first time since 2008, but it was the surge in the Hong Kong stock market that showed the Chinese bubble is finally spilling over, in the form of a blistering rally on the Hang Seng which rose nearly 4% on immense volume which at 250 billion Hong Kong dollars ($32 billion) was three times the average daily volume over the past year and nearly 20% more than the previous record volume day in October 2007, at the height of the pre-financial crisis bubble.”

And here’s the only chart you need to understand how this will end: