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| Bubble in China? The Answer Is Both 'Yes' and 'No' |
| Price-Earnings ratio of 45+ justifies bubble, productive asset valuation indicates further rise |
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Ranjit Goswami (ranjit)  |
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Published 2007-06-03 10:25 (KST) |
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Some seven months ago, the ICBC (Industrial and Commercial Bank of China) rewrote the history of the IPO (its Initial Public Offering, made simultaneously in Shanghai and Hong Kong, was the world's largest to date -- Ed.). Taxi drivers and housewives wagered on the stock (China Set to Make Capitalist History ) and realized some profit on the trade.
Upon listing (with the "greenshoe option"), the ICBC, as the world's fifth biggest financial institution and China's largest, commanded a market-capitalization of nearly US$135 billion (US$ 1 = CNY 7.9), as of October, 2006.
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FROM THE SECTION |
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| ICBC's total market-cap of $228 billion is second only to Citigroup's US $250 billion. HSBC is at $216 billion, whereas the Bank of America's cap is $225 billion. ICBC now quotes at CNY 5.59 against the offer price of CNY 3.12.
ICBC leads the pack in implementing successful banking reforms that three other major Chinese banks have followed; just two years ago, many wrote off the NPA-ridden (non-performing assets -- Ed.) lending practices of these banks.
Financial market valuation, like non-standardized global monetary instruments, in which currencies float in thin air, are also subjective and, as with beauty, lie in the eye of the beholder.
The benchmark China Stock Index (CSI 300) is a cap-weighted combination of the yuan-denominated A-shares (there are two types of stocks issued on the Shanghai Stock Exchange: A shares and B shares. A shares are priced in the local Renminbi yuan currency, while B shares are quoted in U.S. dollars) of the 300 most representative firms on China's two big exchanges (the Shanghai and Shenzhen). Now nearing 4090 and having more than tripled in 2006, alarm bells can be heard everywhere. And the party doesn't stop there ... the main Shanghai index is up 55 percent for the first five months of 2007 year index of B shares is up 129 percent.
Article after article describes how executives, housewives, workers, students, maids, monks, bargirls, nurses and cabdrivers have been investing in China, either full time after quitting their jobs or as a pastime to grow their money. Their story is diverting, indeed.
Chinese authorities have been uttering the usual cautions like the statutory warnings on a pack of cigarette and have asked brokers to get investors to sign a document to the effect that the stock market is not a casino. Greenspan can announce a "dramatic contraction," and people like you and me, with our grounding in Web 2.0, start issuing opinions as if we've been evaluating markets around the world, a la Bloomberg columnists, for years.
Nor is there a chance for you and me to do a hindsight act like Greenspan or the Bloomberg columnists -- because no one really knows. Even the market itself doesn't know who's driving the bus, because fundamentally markets, if free, cannot know.
Chinese "overheating" reflects an attempt by the market to free itself from the monopoly of the money supply that the Federal Reserve Board (the "Fed") has for so long thought its sole prerogative. The Fed is still the gatekeeper, creating and maintaining the primary money supply. What China has cleverly done is it to create another, smaller dam downstream where it accumulates dollars at an unprecedented rate and processes them, thereby releasing equivalent funds in local currency that have then been used for other investments.
China could restrain domestic inflation if it increases the supply side enough, even if the money supply increased, so that what the domestic market couldn’t absorb, in spite of having a market in terms of consumers four times as large as that of the U.S. they would export and further increase the domestic money supply through that secondary dam.
The increased money supply didn't chase the same set of goods or the marginally increasing availability of goods but rather inventories that increased faster than the money supply.
And that is the surprise. Since the demise of the Bretton Woods system, one economy after another has failed miserably to control the second dam ant the domestic supply of goods. As the Fed desires, that second dam could fail or run dry at some point.
The Fed no longer has the option of making the primary dam run dry, even if badly needed for the long term economic health of the U.S. Cheap Chinese imports help in controlling inflation. In other words, overall China and present exuberance of Chinese stocks shows how the Fed. (read the U.S.) have fallen victims of their own ambition.
Note in this whole comparison of money with water, China does not create water as U.S. does. What U.S. exports as inflation to the world as excess water supply; China converts that to productive assets and flows part of it back to the same U.S. so that U.S. itself doesn't face severe drought.
Back in 1945, the U.S. held a majority of investment capital, manufacturing production and exports. In 1945, the U.S. mined half the world's coal (now it's around 20 percent), two-thirds of the oil (now it's around 10 percent in production and 25 percent in consumption) and more than half of the electricity (which now again is close to 20 percent). Guesstimates would have it that back in 1945, the U.S. didn't produce half-the-global-currency (those days, there were some references of paper-money against gold or silver which later received global official status with Bretton Woods).
Any class of asset price would always get determined by simple demand-supply economics. The supply of money that's chasing that asset, the demand of that asset and the supply of that asset would determine the market price of that asset. We talk about free market economies; but the shackle of that free market is kept with central bankers in determining the flow of that all important money. Markets speculate and guess on how lose that shackle would be, or how tight would that be that would critically determine levels of markets in the shorter to the medium term.
Central Bankers on the other hand, more so in democratic countries, are not as worried about levels of markets (or even growth rates) as they are about inflation. Political leaders in power need to win the next election, and inflation pinches the masses.
China that way was lucky as it didn’t fear inflation, as it had no general election. And still it did an excellent job, at least so far, in managing inflation goes with that magnitude of money flow.
In India, policy-makers tell us that high growth rates and high inflation is inseparable. With couple of years of closed to 8-9 percent growth, India is bleeding under inflation (5-6+ percent). In China, in-spite of having that growth rate for couple of decades, inflation ruled mostly at 2-3 percent. Lately in China too, managing that inflation has become a challenge as it shows signs of inching upwards.
Now coming to 45 level of Price-Earning for CSI 300, or 165-level of domestic Chinese FMCG stocks -- aren't they the writing on the wall, in the simplest possible terms for the maid to the cab-driver to see and understand, that there is a bubble?
The answer is an obvious yes. There is a bubble from Price-Earning perspectives.
Looking at Price-Earning ratio alone, and categorizing thereby that Chinese stocks to be in stratosphere bubble zone would be as wrong as to ignore the signs of unsustainable 45 or 165 PE ratios.
What can be the other measures beyond PE? It's the asset valuation model. More so for China as one scale doesn't fit all.
The gross market-cap of China's stocks are around $1.5 trillion -- take a little more as prices are up daily, and that figure may be couple of months old. When Hong Kong is added, where again mainland Chinese firms contribute to a large part of the market-cap; it becomes another couple of trillion dollars.
So at best a GDP of $2.6 trillion (nominal) economy has a market-cap of $3 trillion. India with nearly a trillion dollar economy (with dollars fall lately) again has a market-cap of $1 trillion. U.S. itself with a $13 trillion economy has a market-cap of closed to $20 trillion.
In PPP terms, China's position gets stronger ($8.8 trillion economy having market cap of $3 trillion). True, we may be ignoring two aspects here in our ballpark calculations:(1) Are Chinese firms listed as much as firms in other economies are to get reflected in gross-country-level market cap? If the answer is yes, we are safe. If the answer is no, i.e. a large number of Chinese firms are not even listed (and thereby privately held or held by government); the market-cap comparison with GDP may be a wrong measure.
(2) Are the Chinese firms as much leveraged as firms in other countries are? If the answer again is yes, we are safe. If the answer is, no (i.e. Chinese firms are more leveraged and have higher debt component in their capital); we are wrong. If the answer is no on the other side; we again are safe. Then what explains the warning with stratospheric PEs?
No one is sure. However one possible explanation can be that China alone plays true market economy (sounds strange when everyone knows how China manipulates its currency -- isn't it?).
Well, comparison with India, even if not proper, shows that India produces around 44 million tons of steel, 104,000 MW of power and around 170 MT of cement, and the market-cap for all these firms put together would be around $170 billion. China produces ten times more steel if not more, six times more power and produces seven times more cement.
So in asset valuation model (and assuming Chinese firms to be listed, and on an average, equally leveraged as in India); only firms from steel, power and cement alone in China should have a market-cap of $1.268 trillion; that almost equals the whole of Chinese domestic market cap? What about the ICBCs and jewel Chinese banking stocks?
There is a fallacy here -- and that's about sweating assets to generate profit. If China indeed has created so much assets, why isn’t there profitability? The answer is already covered -- in order to create supply and control inflation, price competition is indeed in cutthroat level in China.
China only offers competition amongst suppliers; in rest of the world, manufacturers and capitalists create cartel to have limited supply to ensure profitability. Many Chinese firms make losses as well; and that’s why the astronomical 45 PE level.
However my limited knowledge does not indicate that China is inefficient, meaning production costs in China to be higher than the rest of the world which make Chinese producers in-competitive. It's rather the opposite -- be it for manipulating currency or for Chinese SEZs.
Others created productive assets with money; and then to protect that productive asset, ensure investments are controlled. China created productive assets with money and didn’t care about protecting its productive assets with formation of cartels.
China is the example of create supply, demand would come whereas others were hesitant to create that magnitude of supply by risking investments if demands fall or fail to pick up.
Isn't there any overvaluation from asset price side? My answer would be no. Rather there still is significant upside for the index (or market-capitalization).
To sum-up; there are obvious market risks, and there are additional China specific risks. The domestic investors won't have currency-related appreciations; and therefore remain more vulnerable in case of a slide. The other problem is, at some point, supply would lead to oversupply (if it's already not the situation in many sectors) leading to assets being unviable to be operative.
The other big risk is potential exports stopping suddenly due to trade-related U.S.-China conflicts (not allowing domestic demand to pick up). However none of these look viable in the short-term.
And Chinese firms is unlikely to be profitable to the same degree as Indian firms. India follows the U.S. model (profit motive) whereas China follows the Japanese model (market-share motive); though that’s an oversimplification.
Needless to say, those societies with less purchasing powers like that in China or India need supplies to be created. India made the mistake here allowing cartels and crony-capitalists to work with less capacity and maximize profit with a huge market; China adopted the other model.
Firms in China may lose, however societies gained. In India, firms made profits and society lost.
Investors and traders gaining and losing is part of all financial markets.
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©2007 OhmyNews
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Ranjit Goswami is a research scholar with the Indian Institute of Technology (IIT), Kharagpur, India; and is the author of the book "Wondering Man, Money & Go(l)d'". |
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 Comments Note: Kindly refrain from personal attacks and profanity. |
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1. Smart, smart
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Kelvin , 2007-06-12 03:14
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