China’s 150 million small investors have had a nasty fright. The Shanghai index of domestic stocks (A-shares), largely closed to foreign investors, had halved between October and last week as government measures such as higher interest rates and taxes on share transactions helped cool the market.
Alarmed by the rapid drop “just before the planned Olympic display of universal Chinese national happiness”, as Edward Hadas puts it on Breakingviews.com, the government last week restricted new share sales and slashed share trading tax back to 0.1%.
The latter boosted confidence and sent shares up 9.3% last Thursday, while H-shares, freely tradeable Chinese shares listed in Hong Kong, rose by over 4%. “When A-shares are doing well, the Hong Kong H-shares follow,” says Richard Lee of Core Pacific Yamaichi in Hong Kong.
Valuations now look more reasonable; Shanghai is on 26 times trailing earnings compared with 70 last year, though it is still on a premium to H-shares’ 16. Emerging markets as a whole are on 15. Tim Congdon of ING reckons the bottom might have been reached, while commodities guru and China fan Jim Rogers has said he has been buying Chinese shares recently: “All the panic looks like a bottom.”
Nonetheless, there seems likely to be more trouble ahead for A-shares, so H-shares may also face a bumpy ride. Investors will stay focused on “second-guessing official intentions”, which presages further volatility, notes Capital Economics. Meanwhile, rising inflation – non-food inflation is picking up – is eating into profit margins and fuelling fears of higher interest rates, while weaker external demand, a rising currency and price controls also bode ill for earnings.
Citigroup recently said it reckons earnings-per-share growth for the Hong Kong and Shanghai-traded shares it covers will halve to 25% in 2008. What’s more, earnings have been inflated by cross-shareholdings in the domestic market. A rally in A-shares “cannot last”, says Morgan Stanley.