China’s stock euphoria is primed to disappoint

Mood swings. Investors of Chinese stocks are in for a rollercoaster ride. Onshore bourses staged a weaker-than-expected rally following a week-long holiday while shares in Hong Kong plunged. True, valuations are cheap and funds remain underweight. But China is vulnerable to more stock market boom-and-busts until Beijing girds its economic pledges with fiscal stimulus.

Shanghai and Shenzhen reopened with a bang on Tuesday, with turnover topping 1 trillion yuan ($141 billion) in the first 20 minutes of trading. That pushed the blue-chip CSI 300 index .CSI300 up 10%. But a sharp selloff in Hong Kong quickly punctured the euphoria. By late morning, mainland stocks were up less than 6%.

Even after the latest swing, the CSI300 is up by a quarter since officials announced a raft of monetary stimulus to prop up equity and property prices in late September. Yet valuations still look cheap at just 11 times forward earnings, per Goldman Sachs analysts, well below the 20 times for Indian stocks. Moreover, as of the end-August, mutual funds were at their lowest China equity allocation in the past decade. Those factors prompted the bank's strategists to raise their forecasts of the MSCI China Index and the CSI300; they now expect total returns for both of 15% to 18% from current levels.

The problem is, Chinese stocks have become more of a trade rather than a long-term investment. Much of the rally has been fuelled by fast-money betting on what Beijing will do next to prop up economic growth. And expectations vary wildly: Morgan Stanley analysts, for example, reckon the central government will soon announce a 2 trillion yuan fiscal package in the coming weeks; meanwhile, a state-run think tank official has suggested something closer to 10 trillion yuan. Little wonder a press conference held by the National Development & Reform Commission on Tuesday, which failed to offer anything new, exacerbated the stock rout in Hong Kong.

The Ministry of Finance may soon step up with other spending plans. Beijing is readying to issue 2 trillion yuan worth of special sovereign bonds to boost consumption and growth, Reuters reported last month, citing people familiar with the matter. With expectations still running high, investors can brace for more volatility.

Context News

China's CSI300 blue-chip index surged as much as 10% during early-morning trading on Oct. 8, the first day after a week-long holiday. Hong Kong's Hang Seng Index fell as much as 9% on the same day.