High earnings multiples
In April 2015, it was observed that the valuations of technology stocks in the Chinese stock markets were on average 220x their reported profits. This made them the most expensive shares compared to similar companies globally. It should be noted that the average PE (price-to-earnings) ratio was 156 when the NASDAQ Composite Index peaked in March 2000.
In the above chart, you can see that Chinese tech stocks’ stock prices like Baidu (BIDU) and Alibaba Group Holdings (BABA) have fallen by over 10% in the last three weeks. Baidu accounts for 1.13% of the Power Shares ETF (QQQ) and 5.01% of the SPDR S&P China ETF (GXC).
Tech heavyweight Qihoo Technology 360 (QIHU) fell by over 8% during the period.
Factors that affect stock prices
Similar to the rise of US Internet stocks 15 years ago, shares in China’s tech sector have seen a massive rise in share prices affected by macro factors like the ruling party’s aim to promote the technology sector in order to decrease China’s reliance on heavy manufacturing and property development. Tech stocks were gaining support due to lower interest rates and a rise in IPOs (initial public offerings) combined with a stupendous rise in investments from retail investors.
Although China’s technology stocks comprise 13% of the total equity market—compared to the US in 2000 at 31%, which decreases the extent of a potential fall out arising out of a sell-off—it also meant that any reversal in market sentiments will severely impact individual investors—due to the losses and risks faced. This ended the seven-year rally of China’s equity markets.
Earlier this year on April 2, 2015, Credit Suisse analyst Vincent Chan stated that “Chinese technology stocks do resemble the dot-com bubble. Given stocks fell 50 to 70 percent when that bubble burst in 2000, these small-cap Chinese shares may face big corrections when this one deflates.”