The performance of the Chinese stockmarket over the past year has been quite incredible—the Shanghai A shares index is up 157%.
For a while now, I’ve been wondering about why the Chinese government seems to be actively encouraging an equity bubble—beyond the usual explanation of compensating for the bubbles bursting elsewhere (property and infrastructure, in this case).
In just a few short sentences, FT columnist John Plender gave me something of an Aha moment in the article Why China is blowing an equity bubble (subscription required and thoroughly recommended). Emphasis is mine:
Why, you might ask, would those charming officials in Beijing wish to encourage a bubble? A consequence of the investment boom is that many state-owned enterprises are lossmaking, while state-owned banks have lent excessively to these companies and to local governments. The authorities are urging them to lend more despite the fact that they will never be repaid in full.
The obvious way to de-risk this dangerous game of extend and pretend is to recapitalise the state-owned corporate sector. Bubble valuations will make this easier and cheaper. Foreign investors, meantime, are set to be granted better access to China’s domestic A shares. While Chinese capital is pouring out of the country foreigners are clamouring to move in.
In short, Plender is arguing that the country’s current playbook looks like this:
1. Boost equity valuations
2. Recapitalise everything, with as much foreign money as possible
3. She’ll be right
Whether it works is anyone’s guess. But you can see how central planners might find the idea an appealing one given the country’s current debt mess.
One thing is for sure—expect to see more Chinese IPO and capital raising documents making it all the way to your inbox. Buyer beware.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.