Trading Nation

This may be the world's most overpriced market

Are Chinese stocks massively overvalued?
Are Chinese stocks massively overvalued?

Notwithstanding a recent turnabout, Chinese stocks have soared this year—and so have their valuations. Based on the widely used forward price-to-earnings metric, the Shanghai composite index appears to be the most richly valued major market on Earth.

The index is now trading at a forward P/E of 24.2, according to S&P Capital IQ. That means that for every dollar of earning that analysts expect these companies to make in the next year, investors are willing to pay $24.20.

By comparison, the is trading at 17.4 times expected forward earnings, and Hong Kong's Hang Seng index is trading at a multiple of 11.6.

In fact, the Shanghai composite has the highest forward P/E of any global national index that S&P Capital IQ tracks. Next on the list are the New Zealand 50 index and the Philippines PSE composite index, which enjoy forward P/Es of 20.2 and 19.5, respectively.

Incredibly, Shanghai valuations have nearly tripled over the past year, as the Chinese market has been liberalized and the Chinese government has loudly encouraged investment. At this time in 2014, the Shanghai index was trading at just 9.1 times future earnings, according to S&P Capital IQ.

That is to say, the year-long, 130-plus-percent rally in the Shanghai composite has been driven not by profit growth, but by multiple expansion. And that has some investors worried.

"It's the most overvalued market in the world, for sure," said Gina Sanchez, a global asset allocation strategist with Chantico Global. "This is just money chasing money."

Sanchez adds that the Shanghai composite has become "a very retail-driven, very momentum-driven market, which means that as it rises quickly, it will also fall quickly."

Dennis Davitt of Harvest Volatility Advisors says that if one must play the rally in Chinese stocks (which he, like Sanchez, does not advise) the best way to do so is through options, which limit downside exposure.

"Sure, they are expensive, but like a good defense lawyer—worth it," the trader quipped.

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