Bloomberg reports that Mark Mobius thinks that China's stock market valuation may surpass the American markets within 3 years:
China’s stock market may surpass the U.S. as the world’s largest by value in three years as state- owned companies sell new shares and the nation’s 1.4 billion people put more of their money into equities, Mark Mobius said.
“The Chinese population is just dipping its toe into equities and they’ve got a long way to go,” Mobius, who oversees about $25 billion of emerging-market assets as executive chairman of Templeton Asset Management Ltd., said in an interview with Bloomberg Television in London. State-owned companies are “coming up with more huge” initial public offerings, he said yesterday.
China’s market is valued at $3.2 trillion, compared with $11.2 trillion in the U.S., according to data compiled by Bloomberg.
I'm not a fan of Mobius and think he is more wrong than right (for instance, he was bullish on emeging markets 6 months to an year ago, with detrimental results) but, nevertheless, I wanted to address this point, which has been made by many others as well.
It would be highly irrational if China's market cap will surpass America's. I hate to predict anything, partly because China is already sitting on some bubbles in my opinion, so anything is possible. You can certainly make money betting on some macro trend even if it is a bubble; but it is very risky and doesn't stand any rational test.
As the article above says, China's total stock market capitalization is around $3.2 trillion, while USA's is $11.2 trillion. If you assume the American stock market valuation roughly stays the same, Mobius is basically saying that he Chinese stock market value will at least triple. Note that we are looking at total stock market value so it doesn't necessarily mean existing security prices will triple. Rather, the stock market value rises because new companies are listed on the stock market (or existing ones issue a ton more new shares).
Here is why this seems like a bubbly scenario to me:
China's GDP in market-exchange terms is around US$4.4 trillion, while its PPP-adjusted GDP is $7.9 trillion. USA's GDP is $14.2 trillion (same value for market-exchange and PPP since base currency used in tabulation is US$.)
If we look at the ratios, here is what we get:
China market cap to GDP (market-exchange terms): 3.2/4.4 = 72.7%
China market cap to GDP (PPP terms): 3.2/7.9 = 40.5%
USA market cap to GDP: 11.2/14.2 = 78.8%
I am not sure if one should be looking at market-exchange GDP or the PPP-adjusted one (anyone reading this know?). I suspect it has to be the market-exchange GDP but am not entirely sure.
If you use GDP in PPP terms, the current ratio (40.5%) is almost half of the US ratio (78.8%). So there is some room for market cap to rise if you assume China's stock market is develops to the level of the American one. But even then, a tripling of the stock market would put it into bubble territory. It depends on how much GDP (the denominator) grows in the next three years but we would probably have a stock market to GDP ratio of around 100% if China's stock market triples.
This ratio rarely goes above 100%, at least in America. In the last 100 years or so—I don't have data for the 18th and 19th centuries—it has only gone above 100% in the late 90's to the early 2000's (basically the technology bubble). I have used this before but to repeat, here is the famous chart that Warren Buffett uses of stock market capitalization to GNP (GDP is very close to GNP so don't worry about that minor difference.)
On market-exchange GDP, China has similar stock ownership (relative to GDP) as USA. If the stock market valuation triples, it would really put it in bubble territory. Depending on how much the GDP (denominator) grows in the next 3 years, you are looking at a stock market to GDP ratio of around 200%!!! This would rival the spectacular dot-com bubble, aka TMT (technology media telecom) bubble, aka 90's New Era bubble. We all know how that ended.
So regardless of the GDP you use, the Chinese stock market would likely be in a major bubble if market cap tripled. Mark Mobius is making the big mistake of paying attention to the trees, while overlooking the forest. The other analysts quoted in the article, talking about private companies versus SOEs, also misses the point. What Mobius says—greater listings or share issuance; more Chinese citizens buying shares—is true. But it is questionable whether that will lead to China's markets surpassing the US market value within 3 years, while avoiding a massive bubble.
Of course, Mobius never says that this wouldn't be a bubble. It's possible that he is investing with the knowledge of a potential bubble. But long-term investors should be really careful investing based on such an outlook.