Stocktake: Bubbly China and price-to-dream ratios

Bubbly China and price-to-dream ratios The word "bubble" is grotesquely overused but Chinese equities are looking, well, bubbly.

The Chinese market is up almost 80 per cent over the past nine months, making it the “best-performing asset class on the planet”, as BNP Paribas noted last week.

Investor frenzy is mounting. A record number of accounts were opened in the week to March 20th; the value of stocks bought with borrowed money hit an all-time high last week; the recent 10-day winning streak was the longest such run in 23 years.

According to Bloomberg, the Shanghai Composite now trades on a median price-earnings ratio of 44.

That’s crazy, as is the fact companies with dual listings are 34 per cent more expensive in Shanghai versus Hong Kong.

Most investors don’t care about price-earnings ratios and the likes, Bocom International Holdings strategist Hao Hong noted recently.

“What about price-to-dream ratio, price-to-guts, or even price to the-greater-fool ratio?” one Chinese investor asked him.

Authorities face a policy dilemma, says BNP Paribas, as equities are keeping confidence afloat at a time of declining property prices and economic fragility.

The bubble “cannot keep inflating, but the authorities’ increasingly cannot afford to let it burst”.

It will burst eventually, but who knows when. In the meantime, says Bocom, "get ready for surging volatility". Biotech mania will end in tears Talking of bubbles, mounting concerns regarding US biotech valuations triggered a big sell-off last week.

This is not the first such correction. Early last year, the sector fell by a third, with Federal Reserve chief Janet Yellen one of many to warn of "substantially stretched" valuations.

Nevertheless, it’s difficult to quell investor fever.

Biotech exchange-traded funds soared some 50 per cent since Yellen's warning, and are up 250 per cent over the last 168 weeks – not far off the 290 per cent gain registered by technology stocks in the 168 weeks leading up to the dotcom peak in March 2000, notes Michael Batnick of Ritholtz Asset Management.

Other metrics suggest biotech gains are “peanuts” compared to the dotcom stocks, adds Batnick, while biotech believers point to upbeat fundamentals (soaring earnings, promising treatments).

Still, a lot of good news is priced in already – the sector trades on almost 50 times trailing earnings and 31 times estimated earnings, way above levels seen in other technology stocks.

A handful of biotechs, no doubt, will deliver for investors.

However, too many are priced for perfection.

Buying into glamour stocks rarely pays off, and this latest market mania will likely end in tears.

See-saw market augurs ill The six-year US bull market has been looking tired for some time now, with last week's losses meaning the S&P 500 has gone nowhere since November.

Recent investor weariness is encapsulated in the fact the index hasn’t managed to post gains in back-to-back sessions since early February – the longest drought since 1994, according to Bloomberg.

There’s been a lot of “up-one-day-down-the-next” action, the index recently flip-flopping on nine consecutive days.

That’s not a good sign, says Nautilus Research, which found 27 past instances of this type of see-saw market behaviour. On average, markets were lower three months and six months later, and flat after a year.

Now, nothing in the statistics indicates a bear market is nearing.

Additionally, averages can mislead – across each of the aforementioned timeframes, indices gained nearly half the time.

Nevertheless, other research confirms that deteriorations in momentum tend to be followed by periods of underperformance.

This year continues to look like it may be a range-bound affair for US markets. Gates of hell or hyperbole? "The gates of hell opened on investors – markets crushed."

That headline, which comes from Yahoo Finance contributor and veteran Wall Street strategist Peter Kenny, relates to last Wednesday, when the S&P 500 collapsed by, er, 1.39 per cent.

Gates of hell?

This is more like gates of hyperbole. Marriage worse than divorce Divorce hurts hedge fund returns, according to a new study; marriage is even worse.

The researchers looked at marriages and divorces among 786 US hedge fund managers between 1994 and 2012.

Alpha – a measure of how much a fund beats the market – fell by 8.5 per cent during the period surrounding a marriage, and by 7.39 per cent during a divorce.

The problem, says the study, is investor inattention. Managers continue to trade and make active bets but they make more mistakes and are vulnerable to the disposition effect – that is, holding losers and selling winners.

Billionaire hedge fund manager Paul Tudor Jones won't be surprised. When a manager is going through a divorce, he said in 2013, "redeem immediately . . . particularly when their kids are involved". The study can be read at http://goo.gl/bqm8dD.