China's stock surge has echoes of the 2015 bubble. What's different this time

Key Points

• Over six months from 2014 to 2015, the Chinese stock market doubled in value, while leverage climbed, Aaron Costello, regional head for Asia at Cambridge Associates, pointed out Monday.
• This time around, the market hasn't run up as much, while leverage is lower, he said. "We're not in the danger zone yet."
• What's less clear is whether economic growth will pick up enough to support a sustainable market rally.

In this article

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BEIJING — The rocket higher in Chinese stocks so far looks different from the market bubble in 2015, analysts said.

Major mainland China stock indexes surged by more than 8% Monday, extending a winning streak on the back of stimulus hopes. Trading volume on the Shanghai and Shenzhen stock exchanges hit 2.59 trillion yuan ($368.78 billion), surpassing a high of 2.37 trillion yuan on May 28, 2015, according to Wind Information.

Over six months from 2014 to 2015, the Chinese stock market doubled in value, while leverage climbed, Aaron Costello, regional head for Asia at Cambridge Associates, pointed out Monday.

This time around, the market hasn't run up as much, while leverage is lower, he said. "We're not in the danger zone yet."

Stock market leverage by percentage and value were far higher in 2015 than data for Monday showed, according to Wind Information.

The Shanghai Composite in June 2015 soared past 5,100 points, a level it has never regained since a market plunge later that summer. MSCI that year delayed adding the mainland Chinese stocks to its globally tracked emerging markets index. Also hitting sentiment was Beijing's back-and-forth on a crackdown on trading with borrowed funds and a surprise devaluation of the Chinese yuan against the U.S. dollar.

This year, the yuan is trading stronger against the greenback, while foreign institutional allocation to Chinese stocks has fallen to multi-year lows.

The Shanghai Composite closed at 3,336.5 on Monday, before mainland exchanges closed for a week-long holiday commemorating the 75th anniversary of the People's Republic of China. Trading is set to resume on Oct. 8.

In the runup to the 2015 market rally, Chinese state media had encouraged stock market investment, while loose rules allowed people to buy stocks with borrowed funds. Beijing has long sought to build up its domestic stock market, which at roughly 30 years old is far younger than that of the U.S.

Strong policy signals

The latest market gains follow announcements in the last week of economic support and programs to encourage institutions to put more money into stocks. The news helped stocks rebound from roughly their lowest levels of the year. The CSI 300 rallied by nearly 16% in its best week since 2008.

Chinese President Xi Jinping on Thursday led a high-level meeting that called for halting the real estate market's decline as well as strengthening fiscal and monetary policy. The People's Bank of China last week also cut interest rates and the amount existing mortgage holders need to pay.

"The policy is much stronger and [more] concerted this time than 2015. That said, the economy faces greater headwind[s] right now compared to back then," said Zhu Ning, author of "China's Guaranteed Bubble."

One week of massive stock gains do not mean the economy is on its way to a similar recovery.

The CSI 300 remains more than 30% below its February 2021 high, a level that had even surpassed the index's 2015 high.

"The Japanese experience provides an important perspective, as the Nikkei 225 Index bounced four times by an average of 34 per cent on its way to a 66 per cent cumulative drop from December 1989 to September 1998," Stephen Roach, senior fellow at Yale Law School's Paul Tsai China Center, pointed out Tuesday in a blog post that was also published in the Financial Times opinion section.

Economic data for the last few months have pointed to slower growth in retail sales and manufacturing. That raised concerns that China's gross domestic product would not reach the full-year target of around 5% without additional stimulus.

"I think what's missing is the key to a lot of this, that has not come out, which would be a truly confidence-boosting measure, is how are they going to fix the local government finances," Costello said, noting local coffers once relied on land sales for revenue to spend on public services.

While Chinese authorities have cut interest rates and eased some home buying restrictions, the Ministry of Finance has yet to announce additional debt issuance to support growth.

Animal spirits at play

Peter Alexander, founder and managing director of Z-Ben Advisors, expects the level of fiscal stimulus — when it's likely announced in late October — to be less than what markets are hoping for.

It "may have investors a little bit over their skis, as people like to say," he said Monday on CNBC's "Street Signs Asia."

He added in a written response that his experiences in 2007 and 2015 indicate the Chinese stock market rally could last for another three to six months, or abruptly end.

"This is pure animal instincts and the Chinese have been pent up for a stock market rally," Alexander said. He added that there are market risks from how unprepared the stock trading system was for the surge of buying.

Data on the number of new retail investors in China this year wasn't publicly available. Reports indicate brokerages have been overwhelmed with new requests, echoing how individuals piled into the stock market nearly a decade earlier. The Shanghai Stock Exchange on Friday said confirming transactions at the market open had been abnormally slow.

Looking for earnings growth

"China was cheap and was missing the catalyst. ... The catalyst has occurred to unlock the value," Costello said.

"Fundamentally we need to see corporate earnings go up," he said. "If that doesn't go up, this is all a short-term pop."

Beijing's efforts earlier this year to stem a market rout included changing the head of the securities regulator. Stocks climbed, only to see the rally peter out in May.

A factor that can send stocks past May levels is that earnings per share forecasts have stabilized versus downgrades earlier this year, James Wang, head of China strategy at UBS Investment Bank Research, said in a note Monday.

Lower U.S. interest rates, a stronger Chinese yuan, increased share buybacks and more coordinated policymaker response also support gains, he said. Wang's latest price target of $70 on the MSCI China index is now just a few cents above where it closed Monday.

— CNBC's Hui Jie Lim contributed to this report.