Risk aversion hits Chinese stocks

NINE DRAGONS PAPER lies at the heart of China's booming industrial relations with the rest of the world: it packages exports. The strength of the business was abundantly clear on March 17th, when it announced record first-half earnings. Immediately afterwards, however, its share price tumbled by 40%. That reflects a pattern during the latest earnings season, says Alvin Chong of Sun Hung Kai Financial, a Hong Kong brokerage firm. Good results: awful stockmarket performance.

Amid nervousness in global markets about risky investments, over-leverage and slowing growth, even China's once impregnable stockmarkets seem to be hitting reality with a bump. There is as yet none of the panic that has afflicted Wall Street. But China's stockmarkets are off by about 30% this year (see chart)—by comparison, the S&P 500 is down by 13%.

China appears to be suffering from a home-grown liquidity squeeze that is not so different from the one afflicting the West. As inflation pushes higher, the Chinese government has curbed lending by the banks. On March 18th the reserve ratio for Chinese banks was raised to 15.5%, the latest in a string of tightening measures.

Tighter credit is likely to crimp expansion plans and hence revenue growth. Higher inflation is also creeping into costs. At Nine Dragons, net margins fell to 15.8% from 20.4%; for years they had increased on the strength of higher sales and more efficiency. The drop, say analysts, was enough to spook an already nervous market. A year ago, Nine Dragons' shares traded at up to 40 times earnings. Now, they trade at 13 times, similar to paper firms elsewhere in the world.

The froth is coming off in other parts of the market too—even China Mengniu Dairy, a company that transformed the dietary habits of a vast nation by making milk a staple, is no longer trading like an internet stock; its shares have fallen by almost a half this year. Much of the pain has been felt by Chinese property developers. R&F Properties and Agile Property, to name just two, saw their share price double or triple between 2006 and mid-2007. They have since lost two-thirds of their value. There is growing concern that smaller developers may have problems raising money to complete building works, which could trigger fire sales.

Not all the troubles are locally produced, however. Adding to the gloom is the waning enthusiasm of foreign investors. As of March 17th the New York-listed Morgan Stanley China A Share fund was trading at a 30% discount to net asset value—more than almost all closed-end exchange-traded funds listed in America. In Hong Kong investment banks say they have huge pipelines of potential initial public offerings, but investors have lost their appetite. On March 17th Want Want China Holdings, a cracker company, managed to raise $1 billion, but only after the valuation on its shares had been cut by more than a third. By last year's standards, that would have been a flop. This year it was enough for people to think that Want Want had lived up to its name.