While the Shanghai A-share index stood at 4,375 on May 23rd representing a 258% gain since the beginning of 2006; the China exchange-traded fund (FXI) made up of primarily H shares listed on the Hong Kong Stock Exchange is up less than 5% so far this year.
The Economist points out several reasons why the Shanghai market may not be a bubble after all. First, it looks at the valuation issue. Chinese shares certainly look expensive, with an average price-earnings ratio of almost 50 (based on historic profits). But p/e ratios are hard to interpret when profits are growing so strongly. Over the past decade China's p/e ratio has averaged 37, much higher than elsewhere. According to Goldman Sachs, firms listed on the A-share market enjoyed an average 82% increase in profits in the year to the first quarter. The article also notes that since 2003, Chnia has been the laggard of the four BRIC countries even with the rapid rise over the last year.
Next, it looks at the likely impact of a sharp pullback in China's market. The total value of tradable shares—that is, excluding those held by the government—is only 25% of GDP (the market capitalisation is nearly 80%). This compares with 150% in America and over 100% in India. Some estimate that only 7% of Chinese hold any shares at all compared to 50% plus in America. But this is changing fast as more than 300,000 new brokerage accounts are opened in China every day!
What is interesting is whether you can now buy H shares in Hong Kong at lower multiples for the same company that trades for on the Shanghai or Shenzhen market. This is certainly something worth looking into.
By Carl Delfeld of the Chartwell ETF Advisor
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