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China Share Price Gains Raise Fears of a Bubble


FILE - An investor gestures in front of the stock price monitor at a private securities company in Shanghai, China.

The rally in Chinese stocks is causing surprise as it moves in the opposite direction from the country's slackening economic growth. Last week, the Shanghai stock index hit a new seven-year high.

The market rally has created as many as 12 new yuan billionaires - those holding about shares worth at least 1 billion yuan ($162 million), mostly in their own companies, according to the Southern Metropolis Daily newspaper.

The Shanghai composite index closed at 4194.82 points Thursday after rising 2.7 percent - it has more than doubled in the past year. The Shenzhen Composite closed at 2,126.15 Thursday, up 1.2 percent for the day. It also has doubled since April 2014.

Last week, and again on Thursday, China's stock indexes hit seven-year highs. That highlights the disconnect between the real economy and stock price movements. In the first quarter of 2015, China's economy grew by seven percent, compared with 7.3 percent growth in the previous quarter. The slower rate casts a shadow on Premier Li Keqiang's plan to achieve 7.5 percent gross domestic product growth this year.

This was the worst single quarter performance of the economy in six years since the financial crisis in 2009. While seven percent growth would be considered quite high for a developed economy, China’s government has supported rapid expansion - often at 10 percent or more a year - to improve living standards and provide jobs.

It also raises the prospect share prices are rising faster than company earnings, and faster than can be sustained, which some stock market analysts warn could lead to a sharp downturn.

“A bubble has been formed, and there might be a major correction anytime. It is a little frightening to see the situation developing because a lot of investors are uneducated people, who might suffer,” said Paul Gillis, co-executive director of the MBA program at Peking University's Guanghua School of Management.

Unsophisticated retail investors, particularly, are at risk because they often put all of their savings into stock markets, so a market slump leaves them with nothing for retirement, education for their children or other major needs.

There are several reasons behind the frenzied investments that have drive up stock prices, including low overall interest rates in banks. Another important reason is the government’s decision to cut interest rates on investment products aimed at wealthier people, Gillis said.

Falling property prices have also led many people to divert their savings to stocks, which has never been the mainstay for Chinese investors. There has been a rise in the number of active stock accounts in China, which grew to 111 million, up from around 95 million a year ago.

The government initially tried to let the stock market advance without restraint, but the central bank started showing signs of nervousness on Thursday. It asked commercial lenders to check for risks in their margin trading business. They have been ordered to furnish authorities with a list of margin trading accounts and connected investment products for wealthy clients. Margin traders borrow money to buy shares, and use their stocks as collateral - but if the share price falls, they can lose large sums of money very quickly.

The People's Bank of China's fears about stock trading is driven by the sudden rush of individual investors, many of whom are believed to have sold properties or borrowed vast sums to invest in shares they barely know about.

Xiao Gang, who leads the China Securities Regulatory Commission, has advised caution.

"We remind investors, especially those new to the market, to be rational and calm when investing in stocks," Xiao said in a speech posted on the CSRC website. "Investors should fully assess market risk, make investments prudently, know their own capabilities and limits, and avoid blindly following the crowds."

The government's fears were also highlighted this week as authorities relaxed rules to allow each investor sign up for as many as 20 trading accounts with brokers. Until now, an investor could have just one trading account.

"The government is trying to protect investors by infusing competition among brokers. Brokers will now be forced to change their pricing and service quality," said Ivan Shi, research manager at Shanghai-based Z-Ben Advisors.

There have been fears that some unscrupulous brokers may be misleading a section of unsophisticated investors, who were beholden to them under the single-trading account system.