How China’s ‘insane’ rally could grind to a halt

Valuation of large Chinese stocks outrageous: Pro
Valuation of large Chinese stocks outrageous: Pro   

Foreign flows, investors using borrowed money to buy equities and a taste for new public offerings have aided a mega-rally in Chinese stocks this year. But analysts are fretting that the good times could end in the blink of an eye.

The blue-chip Shanghai Composite has seen gains of 32 percent year-to-date but has been outpaced by smaller domestic stocks, or A-share indexes, which have seen gains of over 70 percent so far in 2015.

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"They just treat their stock market like a casino, they just poor all the money in," Dickie Wong, the executive director at Kingston Securities, told CNBC Monday, warning of the irrational exuberance of Chinese investors.

"And after the recent gains, they just pour the money into the IPOs (initial public offerings)," he added. He called the Shenzhen index a "bubble" but stressed that Chinese stocks in general are looking "extremely" volatile and risky.

Analysts have warned that investors are borrowing money from brokerage firms to buy more shares -- known as margin trading. Despite a crackdown by the Chinese authorities, Wong believes that more regulation is on the horizon which could lead to a pullback.

"(The authorities) will do something, they will say something to cool down the market," he said.

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Why this expert is not jumping on China's rally
Why this expert is not jumping on China's rally   

Alan Miller, the chief investment officer of wealth management firm SCM Private, noted that one freshly listed firm in China had seen session gains for 34 days in a row and was now trading at a price that was vastly superior to its earnings potential.

"The valuations of the large Chinese stocks are not outrageous but some of the smaller ones are slightly insane," he told CNBC Monday, before warning that "markets always stop before you really kind of know it."

There have been "mini-wobbles" in Chinese indexes with the People's Bank of China trying to curb the usage of margin lending, according to Miller. However, who agreed that a sudden piece of legation from the PBoC could end the lending activity stone dead.

"That has to happen hasn't it? If people are allowed to open up, which they are currently, 20 margin accounts and they are buying on margin because stocks can only go up, that is a recipe for disaster," he said.

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Other market watchers point towards the forms of stimulus that the central bank is injecting into the economy as a reason why a sudden correction will be averted.

Fraser Howie, a managing director at Newedge, told CNBC Monday that he expects Beijing to unveil more stimulus to prop up its stumbling economy. He said it would translate into more upside for equities and added that we could still be talking about the potential for a market correction in a year's time.

"I don't know where the top is, I don't know where it peaks out, but there's no reason to think it can't go (higher)," he said.