Power Lunch

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Power Lunch

The Big Fear: "Irrational Exuberance" In China


China is experiencing a bull market unlike anything seen since the dot-com glory days of the late 1990’s in the U.S. But there could be a big "uh-oh" moment coming.

Analysts, journalists, regulators, even the ruling Communist party, are beginning to take notice that the recent run-up in the Chinese stock market has a lot of the markings of a bubble that’s about to burst. Regulators within the country are worried that the buying frenzy could end badly, although some say it’s just a sign that the Chinese are finally embracing capitalism.

Some background for the skeptics: The Shanghai Composite went up over 130% last year and is already up 9.5% YTD. In addition, Chinese stocks are, on average, trading at over 30 times their price-to-earnings ratio, according to The Wall Street Journal.

What’s happening, says the Journal, is that Chinese day traders are using home equity and even credit cards to invest in stocks that are going straight up. The New York Times also notes this week, in a feature on the Chinese stock market, that young investors without much experience are fueling the rally - and that could be cause for concern that the it can’t last.

Bubble Stocks in China?

CNBC’s international stock screener, Ian McDonald of The Wall Street Journal, was on “Power Lunch” to give some reverse stock picks – those U.S.-traded Chinese companies that are simply too good to be true, and that investors should steer clear of.

The criteria for McDonald’s picks: Chinese companies that trade within the U.S., have at least $2 billion in market cap, P/E ratios of at least 30 and have went up at least 100% over the last 12 months. There were more than a few stocks that met these criteria, McDonald says, but he singles out three:

Baidu.com – Considered “China’s Google” the fourth most popular web site in the world has a forward P/E over 70. Baidu has been so successful that other companies are catching on, McDonald says, and it’s seeing stiffer competition.

China Life – The number one life insurer in the world’s most populous country went up over 100% on its I.P.O and now trades at 8 times its book value, McDonald says, which “outrageously high” for an insurance firm.

CTrip.com – The “Expedia of China,” CTrip is China’s premier travel site. It has a forward P/E of over 60 and, like Baidu, faces increasing competition.

McDonald says that the combination of the influx of new, inexperienced investors coupled with the fact that China classifies stocks in two categories – one for local investors and one for foreign investors – makes the big picture complicated. But just taking a glance at a chart of the Shanghai Compositebegs the question for American investors who saw the dot-com bubble burst: just how much better can it get?