source from：WSJ
MARKETS  STREETWISE
Made in China: The World’s Most Expensive Market
Investors are getting easy access to the Shenzhen market—but at a hefty price

By JAMES MACKINTOSH
Aug. 18, 2016 8:08 a.m. ET
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Investors are about to be welcomed to New China. But can they afford the entry ticket?

The long-awaited announcement of the Shenzhen-Hong Kong trading link means easy access to a market favored by the privately owned consumer, health-care and technology stocks that ought to be the winners from the remaking of China.

Unfortunately, others got there first. Shenzhen is the world’s most expensive major market, one of only two tracked by Absolute Strategy Research trading at more than 20 times forward earnings (the other is New Zealand). The transformation of China is already priced in.

The opposite is true for the state-owned banks and smokestack stocks listed in Shanghai. Shanghai is no longer screamingly cheap, as it was when its trading link to Hong Kong was announced in 2014. But like other emerging markets, its sub-13-times price/earnings ratio is well below developed markets.

Investors face a dilemma. Shanghai is deservedly cheap, dominated by banks that are widely believed to be understating bad loans and with a long tail of unwanted miners and state-controlled industrials. Shenzhen offers growth, but at a high price: 25.7 times estimated earnings for the next 12 months. The median company trades at an eye-watering 67 times trailing earnings, according to research house Gavekal.


Adjust for the very high expected profits growth in Shenzhen, though, and New and Old China seem about equally valued, according to calculations by Kinger Lau, chief China equity strategist at Goldman Sachs. Put another way, valuations seem entirely rational—so long as you agree that profit growth of close to 25% a year is likely from the more expensive companies. As Mr. Lau says, “Expectation for New China is definitely pretty high.”

One argument for coughing up for New China is that Old China is so obviously political. The 10 largest banks in Shanghai make up more than a fifth of its market value, with the smallest of them about the same size as the biggest company listed in Shenzhen. If China makes bank equity holders share the pain of the eventual bailout needed to deal with bad debts, Shanghai’s market will be hit hard.

Yet, the future of Shenzhen stocks is almost as political, for all that its companies tend not to be state-controlled. The government has a lot of say over the pace of the rebalancing of the economy from infrastructure, construction and production to consumption, and frequently slows the shift by boosting lending to Old China, as it did this year. As well as directing bank finance, central and regional governments decide on the pace of shutdowns of unwanted old factories and mines, and of new investment.

Perhaps the simplest proxy for the shift is the exchange rate. If the renminbi is strengthening, money is switched from producers to consumers, from exporters to importers.

Since it began weakening a year ago, China’s currency has fallen against the dollar at the fastest rate since its 1994 devaluation, before rising a little in the past month. It should perhaps be no surprise, then, that Shenzhen hasn’t been outperforming this year, matching Shanghai’s 12% loss.

To justify buying into New China at these prices, investors need to think not only that the country will be able to shift to a consumption-driven economy, but also that it will happen faster than is already priced in. Given the financial and political difficulty of managing the decline of the old and indebted state-owned industries, that requires a lot of faith.