When Beijing lifted a year-long ban on new domestic listings last May, the question was whether the market could support new offerings. Eight months later the new question is: how long can the bull run?
Of the world's markets, only Caracas outshone Shanghai and Shenzhen in 2006; they climbed 130.57% and 127.85% respectively. This stellar performance came after mainland stock markets halved in value between 2001 and June 2005, to hit an eight-year low.
According to Jonathan Anderson, chief Asia economist at UBS, a lower average price-to-earnings (P/E) ratio triggered the resurgence.
At the turn of the decade prices stood at 60 times earnings, far higher than in any other regional market. By 2003 the ratio had fallen to 40, still high for domestic investors. It wasn't until late 2005, when the average P/E ratio stood at around 15, that the market started climbing.
Another key factor was government-led reforms to float the roughly 65% of listed shares that were designated state-owned and non-tradable. About 97% of all listed companies have embarked on the reforms with only 40 yet to announce share transfer plans.
Once the trigger was hit, the pump to fuel the markets was already primed, Anderson said. The source was the almost bottomless deposits already in the banking system, almost US$4.3 trillion at the end of November 2006.
UBS estimates show the stock market rally added US$32 billion in additional monthly turnover during 2006, or US$400 billion for the year. Fund management companies opened more than 6.73 million new accounts in the first 11 months of the year, almost three times the number in 2005, according to China Securities Depository and Clearing.
A December central bank report said that of 20,000 depositors in 50 cities surveyed in November, 10% had invested in funds, the highest proportion in years.
Equity-focused funds pooled more than US$44.8 billion of clients' capital in 2006, nearly tripling the size of the sector through the year, official figures show.
For now, the frenzy shows no sign of abating but a key determinant of market sentiment is the P/E ratio which is creeping up again, according to Bruce Richardson, managing director of research at Xinhua Finance.
"When we get up to the same price to earnings band that you saw in the last peak then you have to start getting out," he said. "In general, any stock market that hits 60 times earnings collapses."
Many observers believe the drive among Chinese investors is often irrational. As one fund manager put it: "People are beginning to act like money doesn't matter any more."
As it stands, there may be too much money chasing too few sound investments and the market is in need of fresh stocks, which are set to come this year. Frank Lyn, China markets leader at PricewaterhouseCoopers estimates mainland IPOs will raise US$25.6 billion in 2007.
According to an official with the Shanghai Stock Exchange, who asked not to be identified, the regulator is speeding approvals of new listings and slowing the approval of new funds to reduce speculation and upward pressure on P/E ratios.
Dealmakers are hurrying their investments to market while the bull-run lasts.
At least one domestic dealmaker admitted to having re-evaluated his business strategy. Whereas before he sought minority stakes in strong firms that would do well in offshore listings, he is now seeking to control up to 70% of promising but unfulfilled companies before feeding them to domestic investors.
"I can get a higher P/E in the Shanghai market," he said, adding that he was embarking on due diligence on a company that he would not have bothered with in less frenzied times
He is counting on getting in, and back out again, before the price to earnings penny drops. But if the regulator and investors are not careful the market could drop with it.