China Stocks on Steroids

ExxonMobil LogoExxonMobil never had a chance!

Once PetroChina decided to list its shares on the red-hot Shanghai Stock Exchange, ExxonMobil’s days as the most valuable company in the world, with only a $40 billion valuation lead over second-ranked PetroChina, were numbered.

When PetroChina’s shares opened in Shanghai on Monday, November 5, they immediately tripled in value and PetroChina sprinted past ExxonMobil as if it were a stock market laggard, not the market and industry leader that it is. PetroChina became the first company in the world to be worth $1 trillion.

Trillions of dollars in savings in China looking for a home, a limited supply of stocks to buy, and stock market mania running rampant on the Mainland all combined to give PetroChina its lofty valuation.

But even before the China stock market made PetroChina the most valuable company in the world by a factor of two, Warren Buffet and Berkshire Hathaway were sellers of the stock at less than one-half the valuation given to the company by the Shanghai market, and Alan Greenspan has been warning all year that the China stock market in general may be in for a correction.

Even as PetroChina’s shares surged in China, they slumped 13 percent in New York, and Bear Stearns and other brokerage firms were putting out the sell recommendations.

What do investors in markets outside China know that Chinese investors don’t? Well, they know that even in today’s world, a trillion dollars is a serious number and not one to be bandied about lightly. To put the number in perspective, consider the following:

  • PetroChina’s $1 trillion valuation is approximately 37% of China’s entire GDP in 2006. By way of comparison, ExxonMobil, with a valuation of $488 billion is only 3% of US 2006 GDP.
  • In 2006, Brazil ranked 10th in the world with a GDP of just over $1 trillion. Russia was 11th with a GDP of just under $1 trillion; followed by India and Korea, each with GDP’s of about $900 billion; and Mexico and Australia, each with GDP’s of about $800 billion.
  • According to Wilshire Associates the total U.S. market cap was approximately $15.35 trillion in May, 2007, about 1.2 times the US GDP of $13.2 trillion in 2006.
  • If the stock market capitalization of a country is roughly equal to its GDP, as is the case with the United States, then the Shanghai market is saying that PetroChina alone is worth more than the countries of Brazil, Russia, India, Korea, Mexico, Australia and all but nine of the largest countries in the world.

Based on company fundamentals alone, it is easy to see why investors like Warren Buffet and sophisticated central bankers like Alan Greenspan have concluded that the China markets are suffering from the same “irrational exuberance” that the U.S. stock market suffered during the Internet boom of the late 1990s. According to Bear Stearns, PetroChina is trading at a 72 percent premium to ExxonMobil in the overseas markets, based upon 2008 price-to-earnings estimates. Based on the valuation in the Shanghai market, it is nearly four times as expensive.

More than five years of double-digit growth in the Chinese economy, combined with currency controls and controls on China stock market listings is creating an increasingly artificial and very dangerous set of circumstances. While China’s Premier Wen Jiabao has warned his government will do what it takes to prevent bubbles and fluctuations in the stock market, the reality is that this is a very difficult thing for the government to do. Accustomed to markets that only go up, Chinese investors are singularly unprepared for the pain which any market correction would bring. China’s stock market genie will indeed be very difficult to get back in the bottle.

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