Last year provided yet another demonstration of the haphazard link between economic growth and share prices. China grew at the slowest rate in a quarter of a century, yet shares listed in Shanghai jumped 53 per cent.

It makes no sense to ask which was right, because current economic growth has little affect on the long-run stream of future profits on which today’s share prices should depend. Even future growth is only tangentially related to shares, as profits per share — vital to prices — depend on many other factors than gross domestic profit.

But it does matter why shares rose so much. There are lots of possible explanations.

The bull case presented by Charles Gave of Hong Kong-based GaveKal is that investors are anticipating a successful transition to slower, but better-quality, growth. Allowing companies to make their own investment decisions should lead to higher returns on capital than China’s bureaucrats have delivered and higher profits in future.

Bulls have been helped by the prospect of further monetary easing to support the economy, after a rate cut three months ago. The flip side is a weakening currency, with the renminbi closing on Wednesday at the weakest since 2012.

Furthermore, shares were cheap at the start of last year, as Short View noted at the time. Investors were worried about a property implosion and bank bad debts, which have so far failed to appear. As confidence returned, prices leapt. The arrival of foreign investors could have helped too. Easier access to domestic A-shares for international investors began in November with the opening of the “through train”. Domestic Chinese stocks took off shortly beforehand and carried on up for the rest of the year.

All these factors helped stocks. But probably more important was the wild speculative frenzy that gripped Shanghai’s bourse. Margin debt boomed, and the effect is easy to see thanks to capital controls. Domestic shares in dual-listed companies last month reached a 33 per cent premium to identical
H shares in Hong Kong (see chart).

China is no longer a bargain. No matter how confident one is on the government’s ability to muddle through, economic reform brings big risks. A-shares are a bet not only on this but on more leverage being available to buy shares.

james.mackintosh@ft.com

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