China's stock market, having been a serial underperformer since the global financial crisis, has been on an epic run over the past nine months.
While the Shanghai Composite tends to get most of the attention when it comes to Chinese stocks there is another index which, in terms of percentage gain, has put that index to shame - the Shenzhen Composite.
While the Shanghai index largely comprises state-owned, traditional companies, the Shenzhen is dominated by 21st century, “new age” firms. To compare it to a more familiar index, it’s along the lines of the Nasdaq.
China’s ‘Nasdaq’ has been on an amazing run. In the past year it has put on nearly 180%. In 2015 alone it has more than doubled. These are staggering numbers, even compared to the Shanghai Composite which is up 50% since the beginning of the year.
Given the scale of the rally it prompted Business Insider to have a look at the average price-to-earnings (PE) ratio for the 1,692 listed firms on the index.
According to the Shenzhen Composite website it currently sits at 64.
While the PE is extremely high, investors are clearly betting that the profitability of these firms will increase substantially. They’re new age, tech-heavy and are going to make a motza — just like firms listed on the Nasdaq were predicted to do more than 15 years ago.
Well, we all know what happened to the Nasdaq. After soaring close to 250% in less than 18 months the index slumped, giving back all of its gains over three years.
Coincidentally, and somewhat unnervingly, on the day the Nasdaq bubble burst back in March 2000, the index PE ratio was at 64 times earnings — exactly the same as the Shenzhen Composite today.
Based on that coincidence, we decided to see how the Shenzhen rally compares to that seen on the Nasdaq 16 years earlier.
Here’s a chart that tracks the Nasdaq from October 8, 1998 — the day the rally really took off. We’ve overlaid the Shenzhen rally on top of the chart from the indices low point last year.
Here’s the same chart, only presented in absolute percentage terms.
As you can see, the Shenzhen rally is well ahead of that seen on the Nasdaq after 265 days of the rally.
While we're not suggesting the Shenzhen rally will implode like the Nasdaq “tech wreck” did, it at least acts as a reminder that there are obvious risks associated with buying companies based on “potential” earnings growth.
Note: As this article was being completed, the Shenzen composite was selling off into the close, and was 5.5% down for the session.