HONG KONG -- China's equities have surged a combined $2.7 trillion in value from a trough in March, raising fears that conditions are akin to the boom and bust in 2015 when Beijing stepped in with a rescue fund to prop up stocks.
The CSI 300 index of the largest Shanghai- and Shenzhen-listed shares is at its highest levels since before the 2015 rout, when an estimated $5 trillion was wiped off valuations. The index has climbed 19% this year and 33% since March 23, the biggest rise among major global stock indexes.
Other indicators, such as daily trading volumes and the number of new investor registrations, have also reached their highest in five years. So has the use of so-called "margin loans" to buy stocks -- raising the risk that investors will not be able to pay back these borrowings if the value of the shares they buy falls sharply.
Chinese authorities themselves have sent mixed messages about whether the sharp rise in activity is beneficial -- or dangerous. This month a front-page editorial in the state-run China Securities Journal spoke of the economic need for a "healthy" bull market. But days later, another state paper, the China Economic Times warned about the dangers of a "crazy" market, and two government-owned funds announced plans to sell their holdings in stocks that had surged.
The China Securities Regulatory Commission also last week published a list of 258 organizations that were illegally providing margin financing and called on investors to steer clear of such firms that were not qualified brokerages.
The question of whether China's rebound from the coronavirus pandemic justifies the surging valuations is important for the wider world, which has much of its hopes for recovery riding on consumers and businesses in the second largest economy. Investors fear a China stock crash will spread to other markets and local investors who are predominantly monthly wage earners, dampening their spending.
China's data on gross domestic product is due on Thursday, when economists expect to see a 2.1% expansion in the three months to June 30 helped by an easing in lockdown measures and policy stimulus after a record 6.8% decline in the first quarter.
Last month, data showed profits of Chinese industrial enterprises rebounded in May for the first time in six months.
As well as the revival in the economy, market participants point to factors including valuation, the level of investor indebtedness and rising corporate profits -- as well as more vigilant regulators -- as being supportive for stocks.
Last week, Morgan Stanley set a 12-month target of 5,360 for the CSI-300 index, some 10.5% above current levels, while Goldman Sachs said it also expected a rising index for the next three months.
The CSI-300 index trades at 13.5 times this year's expected earnings compared with the five-year average of around 12 times. However, Goldman Sachs estimates that when compared on a normalized basis over 24 months, the valuation premium over the five-year average diminishes.
On a relative basis, China A shares -- mainland companies' stocks denominated in yuan and traded primarily on the Shanghai and Shenzhen stock exchanges -- trade at a 40% discount to the 12-month forward earnings of the U.S. S&P 500, the highest since April 2014, Goldman Sachs said.
"China in the context of other global equity markets is inexpensive based on traditional valuation models," said Jim McCafferty, joint head of Asia Pacific equity research at Nomura in Hong Kong. "Corporate balance sheets are also stronger. We are quite optimistic on Chinese equity markets."
While a resurgence in economic activity after the coronavirus shutdowns has boosted investor sentiment, it also revives memories of debt-fuelled speculation frenzy five years earlier when prices doubled over the course of a year.
Borrowing by investors to buy stocks, one of the key drivers of the 2014 to 2015 market surge, stands at 1.3 trillion yuan ($186 billion) as of Friday, which is the highest in five years. However, this is less than half of the amount in 2015. Margin financing as a proportion of total market capitalization hovers below 20% or half the levels of five years earlier, Jefferies analysts estimate.
"It is in the interest of authorities to ensure a healthy and growing equity market as companies are looking to raise capital," said Hao Hong, head of research and chief strategist at Bocom International. "They will look to strike a balance and rein in any speculation or excessive leverage. The rally by no means isn't over as yet."
Hong estimates 12% of daily turnover is driven by margin financing compared with 8% last month and 20% in 2015. The number of new margin trading accounts in June stood at over 85,000, data from the China Securities Finance Corp. showed. While that was the highest since April 2019, it compared with over 700,000 in December 2014.
Daily turnover topped 1.5 trillion yuan on July 6, for the first time since 2015 and remained around that level for the rest of the week, mirroring the spike in late 2014.
"A Chinese equity bull market is building with rising volumes amid improved earnings visibility and liquidity, plus regulatory, policy support," Morgan Stanley strategists Ied by Laura Wang said in a note last week. While regulators might crack down on signs of overheating, sentiment so far is "still below levels associated with unsustainable euphoria in June 2015."
Goldman Sachs analysts led by Kinger Lau in a note last week said they expected a 15% rise for the CSI-300 index from current levels but see the market giving up all the gains over the next nine months."Staying engaged but vigilant about correction risks is crucial in navigating a fast-moving market," they said.
That is already happening at least among a section of the nation's army of retail investors.
Liu Hao, a 28-year-old living in Beijing, has taken to stock investment since he quit his job this year to pursue a career in music. He has already invested 1 million yuan ($142,817) and has not sold any shares despite being up as much as 30% in just six months. He is aware of the risks and said he would keep a close eye on the market.
"I think the market condition is very optimistic right now," Liu said, citing China's strong economic recovery compared with the rest of the world.
Ivy Wei, a 28-year saleswoman in Guangzhou, said her portfolio is up 15% since February. However, she is "concerned" about how long the boom would last and still remembers the loss she suffered in 2015.
"I just wanted to be on the safe side this time," Wei said. She has already cashed out roughly 40% of her holdings.
Rising share prices in China, powered by retail investors, have also widened the gap between these domestic shares and the Hong Kong-listed shares of Chinese stocks, where the market is more driven by international investors.
The current run-up in the mainland has meant the premium over so-called H shares stands at the highest level since 2018, according to the Hang Seng Stock Connect China AH Premium Index.
"I'm fascinated by the fact that H shares have trailed this far behind the A shares," said Tai Hui, chief market strategist for Asia at J.P. Morgan Asset Management. "Is it because domestic investors in China have had a stronger risk appetite? If that is the case, I suspect H shares will catch up, maybe not to the full extent. If A shares continue to remain robust, it does bode well for the Hong Kong listings."
Additional reporting by Coco Liu and Nikki Sun in Hong Kong