Chinese shares face their next big test on Tuesday, when MSCI decides whether mainland securities are eligible for indexes used by $9.5 trillion of funds worldwide.
An endorsement would signal global acceptance for equities that had until recently been off limits to most overseas money managers. Rejection would deal a blow to bulls who pushed the Shanghai Composite Index to a seven-year high on Monday.
While no other stock market has grown this much in dollar terms over a 12-month period, previous booms have arguably had a greater impact when adjusted for purchasing power and the size of economic output at the time.
At the height of Japan's rally in 1989, for example, the nation's market capitalisation reached 145 per cent of gross domestic product, versus an estimated 87 per cent in China today, according to data from the World Bank and International Monetary Fund. The Dow Jones Industrial Average climbed for five straight years in the run-up to the crash of 1929, adding more than 200 per cent.
New share sales
On top of price appreciation, China's $9.7 trillion market is getting a boost from a wave of new share sales. Mainland companies have raised at least $56 billion this year, according to data compiled by Bloomberg.
Optimists are betting that China's Communist Party will keep the rally going to help more businesses tap the stock market for fresh capital. Debt levels for Shanghai Composite companies reached the highest since at least 2005 in January.
People's Bank of China Governor Zhou Xiaochuan, who cut interest rates three times since November, has voiced his support for equity investment as a way to bolster the economy. The Shanghai-Hong Kong exchange link, started at the end of last year, gives global money managers unprecedented access to mainland shares.
"If the government endorses a rally, it will go up," said Nicholas Yeo, the Hong Kong-based head of Chinese equities at Aberdeen Asset Management, which oversees about $491 billion worldwide.
Overwhelming demand
Of course, a flood of share sales runs the risk of overwhelming demand, especially now that valuations have climbed to the highest levels since 2009. At 19 times projected earnings, the Shanghai Composite is 62 per cent more expensive than the MSCI Emerging Markets Index.
Profits in the Chinese gauge trailed analyst estimates by the most in six years in 2014 as the nation's economic growth slumped to 7.4 per cent, the slowest pace in more than two decades.
In the latest signs of weakness, data on Monday showed an 18.1 per cent plunge in imports for May and a third straight month of falling overseas shipments. The Shanghai Composite slipped 0.4 per cent on Tuesday as factory-gate deflation extended a record stretch of declines.
So far, none of that has stopped mainland investors from pouring money into stocks.
They opened a record 4.4 million new trading accounts in the final week of May, while margin debt on the Shanghai exchange climbed to a record on June 8.
For Rabobank's Every, it's only a matter of time before the market falls back down to earth.
"Too many people are making too much money, too fast," he said. "It's greed, fear of missing out, and willingness to suspend belief."
- Bloomberg
