Foreign investors are keenly engaging with new opportunities emerging from China's most recent wave of surging stock market prices, although an increasing number of them are warning against the existence of a bubble in this market.
Their key concern relates to the unreasonably high price-to-earnings multiples of those stocks that are leading the growth of China's domestic stock market, the A-share market, explaining that these high multiples are detaching stock prices from fundamental values.
"A lot of these firms already have very high PE multiples, meaning a lot of work needs to be done to perfectly grow into these multiples expectations," says Robert Davis, Senior Portfolio Manager at NN Investment Partners, formerly ING Investment Management.
"The companies could grow fast, but there is a greater risk that they will not grow as fast to justify their current valuations," Davis says.
Davis' views are echoed by Steve Yang, A-share strategist at UBS Securities. "I think the A-share prices have grown extremely fast in recent months, and we certainly can't have such high growth rate every day because at the current rate of growth we'll have 400 percent growth annually, which is unsustainable," Yang says.
To put the skyrocketing A-share prices into perspective, China's main stock index, the Shanghai Composite Index, has doubled since July last year. It rose from around 3,000 points in February to around to 4,400 in April, becoming the fastest growing stock index in the world.
Alei Duan, managing director of London-based financial advisory firm Abridge Capital International, also says that the current high growth in the Chinese A-share market could be a short term trend and seems unlikely to be sustainable in the long term,
"At the moment Chinese share price growth is largely driven by policy and not by the real economy, which means such high prices can't be sustained unless earnings catch up," Duan says. His views are echoed by Ding Yuan, director of CEIBS Research Centre on Globalisation of Chinese Companies, says that he believes China's A-share market will soon experience a correction because the PE multiples of many small-cap growth stocks are quite high, whilst large-cap stocks are at a turning point of earnings growth.
"For the small-cap stocks, the PE multiples are already extremely high. With a tiny drop of growth, there will be a correction," Ding says.
"For the larger companies, the PE ratio is relatively low, but China is now in a period of transition, and if the new model succeeds, the big-cap firms will suffer because they represent the old economy of China," Ding says. Examples of these big-cap firms include Chinese steel companies, cement companies, and highway and real estate.
Yang says that the driver behind A-share in China is the incremental capital going into the stock market. A lot of Chinese mutual funds and hedge funds have raised new capital in the past three months, investors are using leverage to invest, and many Chinese individuals are now directing their savings into the stock market.
For over a decade, foreign institutional investors have been tapping into opportunities in the A-share market through the QFII (Qualified Foreign Institutional Investor) scheme, although the spectrum of opportunities broadened at the end of last year when China introduced the Shanghai-Hong Kong Stock Connect policy.
This policy allows both institutional and retail investors that trade on the Hong Kong's stock markets to purchase a selection of A-shares, and meanwhile allowing investors in the Chinese mainland to buy H-shares. Unlike A-shares, Hong Kong listed H-shares can be freely traded by foreigners.
Yang says the Shanghai-Hong Kong Stock Connect has received great attention from international investors, and marked an important step in the opening up of China's capital markets. It is also healthy for China's capital markets because some of the capital from domestic investors would flow into international stocks as opposed to be concentrated in the A-share market alone.
