The Great "Stock Market Bubble" of China

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The Great "Stock Market Bubble" of China

China’s stock market has recently been expanding so rapidly that it’s reminiscent of the U.S. dot-com bubble at the dawn of the 21st century. In fact, over the past two years, the Shanghai A-share Index has soared by more than 300 percent. That’s an even bigger increase than the NASDAQ’s rise during the two years before the peak of the Internet bubble in March 2000. In the past six months alone, the Shanghai A-Share Index has ballooned by 100 percent.
Meanwhile, the Shanghai Composite Index, which includes both the A shares, which are yuan-denominated, and the B shares, which are foreign-currency-denominated, broke the 4,000-point barrier for the first time ever in mid-May. This benchmark index rose by more than 50 percent since the beginning of the year.

But even while Chinese newspapers like the South China Morning Post1 are warning that shares are dangerously overpriced, they are fueling the type of speculative frenzy that swept millions of people along at the height of the dot-com bubble. After drawing comparisons to the U.S. boom and bust, the South China Morning Post2 suggests that, “Just because [Chinese] stocks are expensive does not mean they cannot continue rising.”
This is precisely the type of “irrational exuberance” that infected U.S. investors shortly before the NASDAQ market crashed. The fact is that stocks cannot continue rising forever. While prudent, well-timed investments in stocks are the best route to wealth over the long haul, chasing yesterday’s spectacular returns with today’s money usually leads to disaster.

Price-to-earnings multiples of many Chinese stocks have become bloated, swelling from 15 to 50. Yet, the Post contends, “The lure of another 100 percent return should [the market] rise by as much again in the next six months is simply too great for investors to resist.”

What is truly alarming is that there is still a lot of Chinese capital sitting on the sidelines. If that money flows into the market, the bubble could expand and affect millions of additional investors.

Currently, according to The Wall Street Journal Asia,3 Chinese banks are holding more than 36 trillion yuan in individuals’ savings accounts. This is the equivalent of $4.5 trillion in U.S. currency. And, as The Los Angeles Times4 points out, Chinese banks pay just 3 percent interest for one-year deposits, which barely equals the rate of inflation.

Just as in the U.S. seven years ago, Chinese savers are being tempted to empty their low-yielding savings accounts and buy stocks as they hear their friends, co-workers, and neighbors brag about how they’ve quickly doubled or tripled their money in the market...

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