Return of the dot-com bubble

Standard procedure: China's flag flies in front of the New York Stock Exchange before Alibaba's initial public offering. (Lucas Jackson/Reuters)

Standard procedure: China's flag flies in front of the New York Stock Exchange before Alibaba's initial public offering. (Lucas Jackson/Reuters)

The world-beating surge in Chinese technology stocks is making the heady days of the dot-com bubble look almost tame by comparison.

The industry is leading gains in China’s $6.9-trillion stock market, sending valuations to an average 220 times reported profits, the most expensive level among global peers. When the Nasdaq composite index peaked in March 2000, technology companies in the United States had a mean price-to-earnings ratio of 156.

Like the rise of the internet two decades ago, China’s technology shares are being fuelled by a compelling story: the ruling communist party is promoting the industry to wean Asia’s biggest economy from its reliance on heavy manufacturing and property development. In an echo of the late 1990s, Chinese stocks are also gaining support from lower interest rates, a boom in initial public offerings (IPOs) and an influx of money from novice investors.

The good news is the technology sector makes up a smaller portion of China’s equity market than it did in the US 15 years ago, limiting the potential fallout from a sell-off.
The bad news is that any reversal in the industry will saddle individual investors with losses and risk putting an end to the Shanghai composite index’s rally to a seven-year high.

“Chinese technology stocks do resemble the dot-com bubble,” Vincent Chan, the Hong Kong-based head of China research at Credit Suisse Group AG, Switzerland’s second-biggest bank, said in an interview on April 2. “Given stocks fell 50% to 70% when that bubble burst in 2000, these small-cap Chinese shares may face big corrections when this one deflates.”

China’s government is boosting spending on science and technology as a faltering industrial sector drags down economic growth to the weakest pace in 25 years. In March, Premier Li Keqiang outlined an “internet plus” plan to link web companies with manufacturers. Authorities also plan to give foreign investors access to Shenzhen’s stock market, the hub for technology firms, through an exchange link with Hong Kong.

Among the global technology companies with a market value of at least $1-billion, all 50 of the top performers this year are from China. The sector has the highest valuations among 10 industry groups on mainland exchanges after the CSI 300 technology index climbed 69% in 2015 through to this week, more than three times faster than the broader measure.

Top performer
Technology companies have posted the biggest gains among Chinese IPOs during the past year, helped by a regulatory ceiling on valuations for new share sales. Beijing Tianli Mobile Service Integration Company is the top performer among 147 offerings during the period after surging 1?871% from its offer price to trade at 379 times earnings.

Valuations in China are now higher than those in the US at the height of the dot-com bubble just about any way you slice them.

The average Chinese technology stock has a price-to-earnings ratio 41% percent above that of US peers in 2000, while the median valuation is twice as expensive and the market capitalisation-weighted average is 12% higher, according to data compiled by Bloomberg.

“It’s a bubble in the making,” Teng Bingsheng, an associate dean at the Cheung Kong Graduate School of Business in Beijing, said in an interview this week. “Valuations are extremely expensive.”

China lacks some of the most extreme excesses of the dot-com era because of regulations that require any company seeking a listing on the nation’s biggest exchanges to be profitable.

“High valuations don’t necessarily mean that they are unreasonable,” Gui Haoming, the Shanghai-based director of the wealth management research department of the Shenwan Hongyuan Group, the nation’s second-biggest brokerage by market value, said on April 3. “Some of the valuations can be digested by high earnings growth.”

The smaller size of China’s technology sector also makes it less likely that a reversal in the rally will cause a broader tumble in equities. The industry accounts for 13% of the country’s overall market capitalisation, compared with about 31% for the US in 2000, data compiled by Bloomberg show.

It took the Standard & Poor’s 500 index about seven years to recover from the aftermath of the dot-com bubble. The Nasdaq composite has yet to reclaim its high.

Haitong Securities Company’s Chen Ruiming says it’s hard to predict when China’s rally will end, but he sees growing signs of speculative behaviour. The use of margin debt to trade mainland shares has climbed to all-time highs. Investors are opening stock accounts at a record pace.

More than two-thirds of new investors have never attended or graduated from high school, according to a survey by China’s Southwestern University of Finance and Economics.

Rates cut
Money has flowed into Chinese stocks in part because the central bank is cutting interest rates to support growth, something the US Federal Reserve did in 1998 to revive confidence amid Russia’s sovereign debt default and the collapse of the hedge fund Long-Term Capital Management.

Like the dot-com bubble, China’s high-tech boom is creating a new class of wealth – at least on paper. No fewer than 12 technology billionaires have been minted this year, according to the Bloomberg billionaires index. They include Beijing Tianli Mobile’s chairperson Qian Yongyao and He Ye, a co-founder of the Shenzhen InfoTech Technologies Company. That stock has surged 274% since the start of January and is valued at 2 628 times earnings.

“Many of these technology companies have bubble-type valuations as speculators take advantage of popular concepts to ramp up shares,” said Chen, a strategist in Shanghai. “Only a very small group, say 5% or 10%, will make it to become larger companies.” – © 2015 Bloomberg News

With assistance from Allen Wan in Shanghai

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