China’s Bull Market Bullsh*t
|Our Correspondent||Mar 10, 2007|
Everybody knows there’s a China bull market in full force at the moment, despite the shiver that went through equities last week. But if there were any doubt, consider a recent research report from Merrill Lynch in Hong Kong, titled, "Riding the Rural S-Curve."
What is an S-Curve? The broker explains that in ecology, there is a term known as the Sigmoid Growth Curve, or S-Curve for short, which describes a three-phased expansion process. Since this is an ecological term, we presume this refers to the growth phases of ‑ ant hills, grass clumps, mountains? Who knows? But Merrill appropriated the theory last month after China Mobile ‑ the second biggest stock in the Hang Seng Index – hurtled past its price target of HK$72. The broker upgraded to HK$100 – because this level is where, apparently, the "S-Curve" is leading.
Every bull market produces classic lines – remember the guy in 1929 who said stocks would henceforth trade on "permanently high plateaus." These classics at least provide comic relief once it's all over. As the friend who emailed the Merrill report joked, "You think they mean going down the S-bend … (of the loo)?"
It is easy to criticize brokers – as I'm about to do – but first I'll point out I'm highly sympathetic with their dilemma. Bull markets develop their own strange logic, and it's hard to fight. Let's say, for instance, that you are a fund manager who thinks China stocks are overvalued. Indeed, let's say that you believed China stocks were overvalued a year ago. Everyone else jumped on the bandwagon, but you refrained, out of good sense. Which means the other guys' funds went up, and yours didn't.
So investors – those mom-and-pop guys that newly installed New York Gov. Eliot Spitzer wants to protect – begin to snarl and bay for blood and take their money elsewhere.
Investment banks play a crucial role in helping fund managers justify their participation in bubble markets, and if they didn't, they would enjoy no financial rewards. During the Internet-bubble era bankers famously developed all sorts of new valuations which purportedly justified buying new age companies with age-old cash problems. This all came back to haunt them when the bubble burst, and you had multimillion dollar lawsuits accusing banks of failing to give independent advice on companies.
A few years later and what have you got? Instead of "eyeballs" or hits/sales ratios, we've got things like an "S-Curve". In this case Merrill says potential exponential growth in rural areas has made it reconsider China Mobile's worth. But in light of the fact that it will be extremely politically sensitive for China Mobile to make a killing on providing de facto monopoly telephone services to impoverished rural areas, it is hard not to believe that the real reason for Merrill's upgrade is that China Mobile will hit a $100 because the markets are going bonkers (Which is the only reason Amazon once hit its famous US$450 target).
Another hallmark of bubble market investment banking advice is to look at every piece of bad news as a "buying opportunity." Thus, for instance, when China announced it was going to plunk an oppressive capital gains tax to chain down the clearly mad PRC property market, quite a few banks said, "Buy while you still can." CLSA argued that while the "little companies" will suffer cash crunches due to the new rules, bigger companies can now move in and grab market share. True perhaps – but then the PRC will still take a huge chunk of their profits under the new rule anyway.
Instead of digging deep for "fundamentals" to back up the mania, a cleverer approach might be for brokers to rely more on euphemisms that effectively say, "Stocks will keep going up because lots of greedy morons are buying them." Take, for instance, Citigroup's upgrade of price targets for Chinese banks. This came in January, when people in the streets were practically drawing swords and dueling to get in on hot China IPOs, especially ICBC, which in November launched the world's biggest ever IPO.
Although Chinese banks are very possibly stuffed with fresh high-margins loans that have been issued into an investment bubble, Citigroup says they deserve their premium over other banks, due to a "scarcity premium". In other words – even though this is the biggest initial stock sale ever, there is still not enough of the shares to go around.
"Momentum" is another piece of useful jargon. Here's what Citigroup's strategist wrote recently on the subject: "[Our financial] models highlight increased valuation concerns but momentum support."
In other words – stocks are overvalued but there's a lot of money out there that will keep pushing them up. This is a fair, straight-forward argument, which is a lot less disingenuous than reaching for "fundamental" justifications for buying stocks at bubble.