China's Bubble May Not Spell Trouble for Global Investors

S&P’s Asia Strategist Lorraine Tan says, “Smart money may start to diversify.” In a note published earlier this week, Tan wrote, “Recently, a Xian-based newspaper (Sanqin Daily) reported that a monk has opened a share trading account in China. While his intention is to make profits for charities, the news is undoubtedly a potential indicator of how bubbly things are in China’s domestic stock markets. While the clarification on individual participation in the QDII scheme was indeed a positive development, we believe that the market is running ahead of fundamentals. This may continue for a while, however.”

China wants more money to be invested abroad to slow the growth in the country’s $1.2 trillion in currency reserves, which are flooding the domestic market with cash, according to Bloomberg. Local investors have traditionally shunned QDII because they had been limited to lower yielding fixed-income and money-market products. Alternatives for the retail investor include savings accounts yielding under 3%, for example.

Collectively, China’s Shanghai and Shenzhen markets surpassed Hong Kong’s capitalization in March, as investors sought higher returns than the 2.79% one-year savings rate at banks. The Shanghai A-shares market has risen more than 45% so far this year through May 16 after a 130% increase in 2006, while Shenzhen A-shares have more than doubled year to date after nearly doubling – rising 96% — in 2006. Both the Shanghai and the Shenzhen Composite Indexes have set new records in the last week. China’s CSI 300 Index has surged about 80% this year, after more than doubling in 2006. The surge has prompted officials including People’s Bank of China Governor Zhou Xiaochuan to warn of a stock market bubble.

However, S&P’s Young points out that although a near-term decline in China’s local market is likely, he does not believe it will lead to a repeat of February’s global stock market rout because China’s economy is likely to remain strong through the 2008 Olympics next summer. “February’s lesson was that there is a disconnect between movements in China’s insulated and illiquid local stock market and the momentum of the real economy. In Young’s view, “As long as China’s real economy remains strong, U.S., European and Asian companies will continue to profit from Chinese growth allowing global markets to largely shrug off local profit taking in China.”

Last month, Chinese regulators declared that companies raising money through the stock market must get approval from shareholders if they want to re-invest it in other companies’ shares. It was an attempt to curb the amounts of money flowing into Chinese stock markets. In a recent survey of 20,000 households conducted by the Peoples Bank of China, 30.3% said they intend to invest in stocks and funds. With banks offering at best 3 percent on savings, for them the choice is an easy one – for China’s Government it’s a frightening trend.

Now, with the new rule, the government has granted a total of $13.4 billion in QDII quotas to 15 commercial banks. Hong Kong’s stock market may be the biggest beneficiary, China International Capital’s Chief Economist Ha Jiming told Bloomberg News, “Hong Kong is the most natural starting point as the QDIIs are most familiar with the Hong Kong market, especially the Chinese companies listed there,’” he said.

China is leading the world in IPO volumes and new share offerings are often doubling in value on the first day of listing, a trend that is seeing shareholder accounts burgeoning by millions each month. The CRBC’s new regulations still prohibit banks from investing in hedge funds, commodity derivatives and securities rated below investment grade, the banking regulator said. Individuals will still be barred from investing directly overseas.