Chinese stocks have crested to an all-time high at the same exact time as their U.S. counterparts. It's no coincidence. It's also unrealistic.
The world's two largest economies are behaving very differently after the coronavirus. China's growth is back on track after an aggressive, socially punitive response to stamp out Covid-19 outbreaks. The United States may be seeing falling rates of infections now but has muddled through a disastrously confused first year under the virus, where public health warnings often were ignored.
Freedom has been absent in China. But it has also been misinterpreted in the United States. Freedom does not mean "Whatever suits me best" or "Whatever I want to do." The pursuit of life comes before liberty and happiness in the Declaration of Independence, and if you need to wear a mask for the collective good it is not infringing your unalienable rights. The very next sentence of the declaration begins to address how government is necessary to lay out principles and powers - rules, laws - to ensure public safety and happiness. We can live free without having to die of Covid, or cause others to.
But I digress. What do we make of these new highs, with the CSI 300 of the largest companies listed in Shanghai and Shenzhen peaking at 5,931 on Thursday after the Lunar New Year break? The index jumped 2% at the open to its record, then flagged a little later in the day due to central bank curbs on interbank lending, but still rose 0.2% on Friday to finish at 5,779. Thursday was the first day in five for investors to be able to buy shares, which is now in the Year of the Ox, or Bull if you like market symbolism.
Chinese stocks broke through their levels set in 2015 during a period of similar stock-buying fervor. That ended badly. Really badly. The Chinese market doubled and then some, up 159% in the year through June 2015. Three months later, it had cratered 42%, although the lows it set then have proven an impervious barrier against further downside.
The all-time high for Chinese shares was set in 2007, shortly before the financial crisis in the West. That rally was even crazier, with Chinese equities quadrupling in a year at a time the country began letting its currency trade more freely and double-digit annual economic expansion was the norm.
The current buying surge shows similar patterns. The gains have not been of the same magnitude, but the Shanghai-Shenzhen index is up 58% since the Covid-induced lows of last March. It's a worrying sign that margin lending on equities has risen close to C¥1.5 trillion (US$211 billion), also a high since the crazed buying in 2015, when borrowing to buy shares rose as high as C¥2.2 trillion (US$310 billion).
Chinese markets are notoriously driven by retail investors, who pile in when the buying is good. If the market turns bad, they've often asked for "refunds" from the Communist government, the worst excesses coming when investors believe capitalist stock markets only known one direction: up.
U.S. markets have also seen furious retail participation, of course. Perhaps many newbie investors also believe gravity has been reversed for stocks. Quant purchasing has perpetuated the upward movement, with short-selling investors forced out and into long buying. Even long-only fund managers and index trackers are pressured to purchase into the rally, whether or not they believe it's warranted, if they are to keep pace with the broader market.
The S&P 500 is trading at considerably higher valuations, at 32x trailing 12-month earnings. That compares to 22x in China. But it makes sense there is a risk premium on developed-nation stocks. Chinese shares are little better than futures on stocks, I always argue, because the Beijing government can literally change the operating rules for any industry overnight... and often does. Any company can be brought down if the Communist Party deems it a threat. Alibaba Group Holding BABA co-founder Jack Ma, widely said to be under a form of house arrest, is finding that out at his cost. Ant Group, Alibaba's would-be fintech spinoff, has recently agreed effectively to recast itself and operate under the oversight of banking regulators, its record-setting initial public offering pulled at the last second.
I wrote on Wednesday about the Nikkei 225's ascent to its highest level since 1990 and the bursting of Japan's post-war bubble. It closed Friday still above the 30,000 level, at 30,017, after setting a three-decade high water mark at 30,702 on Tuesday.
Although not quite an all-time record in Tokyo, it might as well be. The excess of the 1980s drove Tokyo shares into the stratosphere, setting an unrealistic and fanciful level at 38,916 in December 1989. It is remarkable that, with the Tokyo market essentially doubling since the lows of last March, we are close to testing that level once again.
China in many ways has taken the same shape as 1980s Japan. It is the world's production powerhouse, progressing into high-value components and products from an initial base of churning out cheap stuff. The rebound in China's economy, expected to bounce between 8% and 9% this year, is production-driven, dependent on factories rather than consumer demand. The Lunar New Year holiday was more muted than normal, but did at least demonstrate some signs of normal life.
Movie ticket sales have been particularly good, with many Chinese people traveling less and more than a bit bored. The first day of the New Year last Friday brought in C¥1.7 trillion at the box office, higher than the C¥1.4 billion take in pre-pandemic 2019. Some 34 million people went to the theater, breaking the 33-million record set in 2018.
It is surely time to trim risk. CCB International, the overseas arm of state-run China Construction Bank, one of China's "Big Four," says its global portfolios "are still running at close to maximum risk," particularly in terms of volatility. It believes rising bond yields are a signal to scale back on risk, with its "cost of capital indicator" rising sharply.
The cost of capital indicator may turn positive next week, CCB global strategists Mark Jolley and Yao Diliu anticipate. That would signal a shift to risk aversion. Developed equity markets would be particularly exposed, as would any nation that is not underpinned by decent fundamental growth in its economy.
Buyer beware across the United States, China and Japan, with all indexes racing well beyond levels justified by what we are seeing in real life. The equity markets have priced in all the good news on viral recovery and the return to normality, and then some. If the past progress of China's stock market is any guide, a hefty correction will soon be in store.
