China's Stocks, World's Costliest, Defy Global Slump

- The 14 percent rally in Chinese stocks in the past two weeks has created some of the largest companies in the world by market capitalization and defied a global rout that wiped more than $3.3 trillion from equities worldwide.

The gains helped Industrial & Commercial Bank of China Ltd. attain a market value that exceeds all but two U.S. companies, Exxon Mobil Corp. and General Electric Co. In banking, ICBC's $285.2 billion market capitalization dwarfs the $233.8 billion of Citigroup Inc. even though ICBC's $6.5 billion in 2006 earnings were less than a third of the U.S. bank's.

Relative prices indicate China's rally should be losing steam. ICBC's Shanghai-listed shares trade at 39 times reported earnings, almost four times Citigroup's multiple of 11. Shares in China's CSI 300 Index trade at 50 times profit, while those in the Standard & Poor's 500 Index trade at 17 times.

``It's more a matter of momentum rather than valuations,'' according to Gabriel Gondard, who helps manage $6.6 billion at Societe Generale's Fortune SGAM Fund Management Co. venture in Shanghai. ``There's a lot of liquidity flowing into the market.''

The CSI 300 has more than tripled in the past year, driven by local investors seeking returns above the inflation rate, which reached a 10-year high of 5.6 percent in July. Rules limiting the flow of money offshore have funneled savings toward the country's stocks and mutual funds.

Trading by individual investors accounts for about 60 percent of market volume, according to estimates by Shanghai-based brokerage Guotai Junan Securities Co. In the U.S., individuals account for only 5 percent of trading.

The CSI 300 rose to a high today, adding 74.28, or 1.6 percent, to 4,795.57 at the close.

Offshore Investing

China's plans to let more locals invest overseas will curtail stock gains over time, according to Societe Generale's Gondard.

``In the long run it can't stay this way,'' said Gondard, who favors financial and property stocks but declined to specify his holdings. ``I won't say that we're selling just yet, but we're keeping a cautious stance about what's happening.''

The government is expanding its so-called qualified domestic institutional investor, or QDII, program that grants licenses to move funds to offshore markets such as Hong Kong. Last month the program was applied to all China fund managers after a trial period.

China's banks and fund management firms have so far been approved to invest a total of $15 billion in stocks, bonds and fixed-income derivatives outside the country. Household savings in the country amounted to 16.9 trillion yuan ($2.2 trillion) at the end of June, according to the central bank.

Exceeding GDP

Insurers may also become large QDII investors after their cap on investing abroad was raised last month to 15 percent of assets from 5 percent. Insurers had 2.53 trillion yuan of assets at the end of the first half.

``We expect China's total QDII outflow to be about $90 billion in the upcoming year, and this is merely the beginning,'' said Jing Ulrich, chairman of China equities at JPMorgan Chase & Co. ``Chinese funds will become a major force in global markets as the government liberalizes capital flows.''

For now, that money is fueling gains in China.

The market value of shares listed on the Shanghai and Shenzhen stock exchanges has swelled by $1.65 trillion this year, equal to the combined value of stock markets in India and Singapore. China's shares were valued at 21.15 trillion yuan on Aug. 9, exceeding the nation's 2006 gross domestic product of 21.09 trillion yuan for the first time.

New Accounts

The CSI 300 has risen 14 percent since July 23, the day before a global sell-off sparked by concern U.S. subprime mortgage losses will spread through credit markets. Saudi Arabia's Tadawul All Share Index, the next best performer among 89 benchmarks tracked by Bloomberg, is up 6.9 percent.

After China, Peru is the second-most expensive market. The Lima General Index has an estimated PE of 44.

Investors in China have opened about 33 million brokerage accounts already this year, more than six times the total for 2006. Daily turnover on the nation's two stock markets soared more than fivefold to 202.7 billion yuan in the first six months, according to the People's Bank of China.

Government steps to try to cool the economy and stock market so far have had limited impact.

The central bank last month raised its benchmark one-year lending rate to an eight-year high of 6.84 percent and increased the proportion of deposits banks have to hold in reserve to 12 percent from 11.5 percent.

Hot Economy

A tax on securities trading also tripled on May 30, to 0.3 percent, to curb stock-market speculation, triggering a slide of as much as 16 percent in the CSI 300. Shares have since rebounded as economic expansion draws investors.

China's economy grew 11.9 percent in the second quarter, the fastest pace in 12 years, and industrial expansion gathered pace, the statistics bureau reported last month.

``We definitely foresee a lot of potential measures to be undertaken by the government to contain the stock market at large,'' said Emerson Yip, who helps manage $6.9 billion of Greater China investments for JF Asset Management Ltd. in Hong Kong. ``The government is trying to manage expectations.''

Tao Dong, chief Asia economist at Credit Suisse Group in Hong Kong, predicts the lending rate in China will rise by 0.54 percentage point this year and 0.81 percentage point in 2008.

The prospect of higher rates isn't enough to drive individual investors such as Pan Weiting from the market. Pan, a 24-year-old accountant from Shanghai, said she reaped a 30 percent return from her investment of 50,000 yuan this year.

``None of the factors that support a bull market, such as fast economic growth and rapid corporate earnings growth, have changed,'' she said. ``I won't sell my shares at this stage.''