With such a short history I’m suspicious of ‘proofs’ about anything extracted from China stock market data. I’m also reluctant to allow China’s stock markets any degree of Chinese-ness in terms of explaining their long run valuations. Local factors can matter from time to time but ultimately, just as people are people, stocks are stocks wherever you go.
The issue of how China stocks should be correctly valued is now doubly pertinent.
First the Hong Kong-Shanghai connect will allow new investors directly into China’s domestic A-share market and a reliable valuation compass would be a handy tool in those, for many, uncharted waters.
Second, China shares in HK (barring a sudden and significant rally) are likely to experience a sixth straight year of P/E compression and investors may be forgiven for asking if a ‘China discount’ is a factor that needs to be included in future fair value calculations?
The paper highlighted this week is from 2010 and is the first I can find that addresses this issue head on. It’s from the European Central Bank and it analyses the A-share market from April 1999 to September 2009 (sadly, a statistical blink) to see if the basics of earnings, risk free rates and equity risk premiums are reliable explanatory variables over the period? The good news is, it seems they are.
Two booms occurred over the period and those are explained by unique local conditions, specifically liquidity surges (as evidenced by rapid monetary growth in each case); but I think most would acknowledge liquidity, in all markets, is just another explanatory variable?
The jury will remain out for a long time but I think it’s likely more evidence will accrue over time that China’s domestic stock markets are less of a retail-driven game of Las Vegas Craps than many today (not without some justification to be sure) believe them to be.
The full paper can be accessed via the following link http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1190.pdf
Happy Sunday