History Happening Again – China

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We all know that past performance may not indicate future investment returns. However, past history does give us a glimpse of future events. To our readers who have been following us on Twitter, we have constantly been tweeting about the Chinese economy. For the benefit of those who do not, here is a consolidation of the main articles.

10 Jun: Chinese farmers hope to harvest bumper stock profits

17 Jun: The China Bubble Is Going to Burst

26 Jun: Chinese Stock Plunge Leaves State Media Speechless

29 Jun: China’s $8 Trillion Penny Stock: The Market of Boom-Bust-Repeat

If one has been following the Chinese news, one would realise that the surge in Chinese stocks have been attributed to the following reasons.

  • Leverage. Many brokerages are now offering small time investors to leverage up and investors have been more than eager to accept margin trading.

“It’s worth the risk,” said Jiang, while admitting she doesn’t fully understand how margin finance works because she hasn’t had her broker explain it to her.

  • Small-time Traders. Many of the investors are young and small-time day traders with little understanding of what they are investing in. Just in March alone, there was nearly 5 million trading accounts opened and this trend continued on in April. Furthermore, there is a large proportion of these new investors who did not complete high school.

Reading such news, it reminds me of the lead up towards the Dotcom Bubble. Everyone participated in the craze, thinking that the stock market was just going to get higher and higher, adopting a mindset of buy high sell higher. What started out as a logical investment thesis resulted in lofty valuations not just for technological stocks but non-technological companies too.

Furthermore, we saw many respectable business publications such as Forbes and Wall Street Journal encouraging the public to invest in such companies, despite many of the companies’ disregard for basic financial and legal principles.

Looking at China, valuations have reached a point where it can be said to be just ridiculous. ChiNext, has a trailing PE ratio of ~90, which is more than double that of internet stocks at the peak of the dotcom bubble. While the idea of investing in China companies to ride on the growth of the Chinese economy was logical, at current valuations one has to question if we are just allowing history to repeat itself.

Furthermore, we believe that while the Chinese government is taking the right steps in improving the corporate governance within China, it is still not at a stage that offers us comfort in investing in such companies.

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