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June 17 (Bloomberg) -- Eastern Bay Investment Management’s James Zhong is selling China’s small-cap stocks after the steepest rally worldwide pushed valuations to the highest level since the shares peaked in January 2008.|
“We’re seeing a bubble in small-cap stocks,” said Zhong, who helps oversee $220 million in Hong Kong. Zhong predicts the CSI 500 Index, a benchmark for China’s 2.1 trillion-yuan ($307 billion) market for small-cap equities, will slide as much as 30 percent “in the near future” because he expects companies will report first-half results that disappoint investors. The index gained 1.6 percent to 3,403.96 at the close today.
The jump in mainland-traded equities with a median value of 3.8 billion yuan pushed the price-to-earnings ratio for Shenzhen Topraysolar Co. to 110, data compiled by Bloomberg show. Xuzhou V V Food & Beverage Co. fetches 160 times profit, almost double its PE ratio of 87 at the top of the last bull market. Beijing Vantone Real Estate Co. shares rose 171 percent since Nov. 9, even as analysts cut their earnings estimates by 35 percent.
Seven months after China’s worst bear market on record ended, mainland stocks are rallying on expectations that a surge in lending and an expansion in manufacturing will help the economy grow at the government’s projected 8 percent pace this year. The CSI 500 climbed 118 percent since the announcement of Premier Wen Jiabao’s 4 trillion yuan stimulus package on Nov. 9, the steepest gain among small-cap equity benchmarks worldwide.
Zhong, KBC Goldstate Fund Management Co.’s Larry Wan and Hamon Asset Management Ltd.’s Nina Wu say the advance has gone too far after the CSI 500’s PE ratio jumped to 68, near the level of 69 when the index peaked at 5,487. The CSI 300 Index of China’s largest companies, up 79 percent since Nov. 9, is trading at about half its valuation when the measure rose to a record in October 2007, according to Bloomberg data.
“Greed has trumped fear” for buyers of small-cap stocks, said Wan, the Shanghai-based chief investment officer at KBC, which oversees about $730 million.
Investors opened 8 million new brokerage accounts since Nov. 9, 20 percent more than the previous seven-month period, according to data compiled by the China Securities Depository & Clearing Corp. Shanghai Stock Exchange trading more than doubled to an average 12.8 billion shares a day, Bloomberg data show.
Domestic banks extended a record 5.84 trillion yuan of loans in the first five months of 2009, almost triple the value in the same period a year earlier. The central bank has cut interest rates five times since September, scrapped quotas that limited lending and pressed banks to support the government’s stimulus plan. Zurich-based UBS AG forecasts new credit may reach 8 trillion yuan in 2009.
“Bubbles almost always occur as markets adjust to rapidly increasing liquidity and it’s obvious we’ve had a massive increase in liquidity in China,” said Michael Pettis, a finance professor at Peking University in Beijing and former head of emerging markets at New York-based Bear Stearns Cos., which was acquired by JPMorgan Chase & Co. in May 2008.
Small-cap stocks rallied around the world this year as central banks cut interest rates.
The MSCI Emerging Markets Small Cap Index, a benchmark for developing nations worldwide, advanced 51 percent, compared with a 33 percent gain in the large-company gauge. The Russell 2000 Index of small-cap stocks in the U.S. added 0.9 percent, while the Standard & Poor’s 500 Index gained 1 percent.
The developing-nation small-cap gauge trades for about 18 times earnings, according to Morgan Stanley data. MSCI Inc.’s index of small-company shares in India, the second-fastest growing major economy after China, is valued at 12 times profit. Brazil’s small-cap index trades for 28 times earnings, a 59 percent discount to China.
China hasn’t reached a bubble because earnings are set to rebound in the second half, said Fortune SGAM Fund Management Co.’s Gabriel Gondard.
Companies are expected to post a 16.6 percent increase in 2009 earnings, according to analysts’ estimates compiled by Shanghai Wind Information Co. That compares with New York-based Morgan Stanley’s estimate for a 25 percent profit decline for companies in developing nations worldwide.
“We have to get set for rapid changes in corporate earnings” as the government’s stimulus package takes effect, said Gondard, the Shanghai-based deputy chief investment officer at Fortune, which oversees about $7.2 billion and has been buying consumer and infrastructure-related shares.
Mark Mobius, who oversees about $20 billion as executive chairman of Templeton Asset Management Ltd. in Singapore, said in a June 4 interview that stocks traded in mainland China are “getting close” to bubble levels, though “valuations aren’t completely crazy.” The money manager buys Chinese stocks traded in Hong Kong, where he said he can purchase shares at discounts of about 40 percent to mainland-traded equities.
The rally in China may end because new loan growth is slowing from a record pace this year, said Zou Xiang, who oversees $1.7 billion as chief investment officer at SYWG BNP Paribas Asset Management in Shanghai.
Banks offered 664.5 billion yuan in credit in May, according to the People’s Bank of China. The figure is 35 percent of the record 1.89 trillion yuan in March and is the second-lowest level in 2009 after 591.8 billion yuan in April.
“There are clear signs emerging that the loans market is contracting,” Xiang said in an e-mail. “Demand for funds is starting to decline.”
Chinese stocks have a history of collapsing after rallies. The Shanghai Composite Index jumped more than five-fold from the end of 2005 through October 2007 in what Li Ka-shing, then Asia’s richest man, and former Federal Reserve Chairman Alan Greenspan called a bubble. The Shanghai gauge fell more than 70 percent over the next 13 months as a tumble in Chinese exports and private investment slowed economic growth to 9 percent in 2008 from 13 percent the previous year.
Shenzhen Topraysolar rallied 365 percent since Nov. 9 as China set a goal to double the use of renewable energy by 2020 and introduced a subsidy for solar projects. Analysts expect earnings to climb 42 percent in 2009 after falling the past three years, according to estimates compiled by Bloomberg.
“New energy stocks listed in China have rallied too much without seeing strong earnings improvement,” said Hamon Asset Management’s Wu, who runs the $712 million Dreyfus Greater China Fund and beat 98 percent of her peers this year. It’s “where I see the biggest bubble,” she said.
V V Food & Beverage, a producer of fresh milk based in Jiangsu province, has jumped 230 percent since Nov. 9 as earnings doubled in the first quarter.
Beijing-based Vantone rose as China property sales increased 45 percent in the first five months of 2009 from a year earlier to 1 trillion yuan, according to the country’s statistics bureau.
The stock trades for 25 times analysts’ estimates for this year’s earnings, compared with 16 times for Sao Paulo-based Cyrela Commercial Properties SA Empreendimentos & Participacoes, a unit of Brazil’s biggest real estate company.
KBC’s Wan said the valuations for Chinese small-cap stocks make them too risky to buy.
“This is outright gambling,” he said. “I’m leaving this to those who can dance with wolves.”