The Chinese equity market bubble is looking riskier by the day. The herd stampede into stocks in China has produced the staggering gains characteristics of advance-stage bubbles:
--The average first day gain for Chinese Intitial Public Offerings (IPOs) is reportedly 192%;
--The 10 largest IPOs were up 83% on average on the first day;
--China is leading the world in IPOs for the second straight year;
--The benchmark Shanghai stock index is up 121% year-to-date.
The most serious aspect of this mania is the pervasiveness of rationales defending its rationality. We are told that this situation is DIFFERENT because Chinese companies have earnings, unlike internet companies in the U.S. during the internet stock bubble of the late 1990s. There are also a number of technical reasons being cited to justify the price run-up. The principal rationale is actually identical to the one offered to justify the rationality of the explosion in emerging market stock prices generally; these countries are growing, earnings are growing, it is not a bubble.
It is true that the emerging economies are growing, and it may be true that earnings growth among Chinese companies is solid as well. The problem is in VALUATIONS. Even if a company is growing its earnings by 20%/year -- a rate which is unsustainable over the long run in the overwhelming majority of cases -- that does not mean that a price/earnings multiple of 200x earnings is justified or rational or sustainable. It does not mean that a crash is not coming, or that the bigger the bubble becomes, the more severe the coming collapse will be.
Above all, the arguments and explanations being adduced to explain, justify, and rationalize this latest outbreak of tulipmania fall in that familiar generic category: THIS TIME IT IS DIFFERENT. As we have noted before, these are the words that should send you running to them thar hills. It is NEVER different.
The significant issue about the inevitable future crash is: what will the consequences be for the Chinese economy, and for the global economy? As the size and saliency of the Chinese economy grows, the impact on other important economies will increase. All the assurances to the effect that a stock market collapse in China will not affect Chinese economic growth have a familiar ring in our skeptical ears. We have heard it all -- and seen it all -- before. Ten-foot tall markets, and ten-foot tall economies, are almost always cut down to size.
