VZCZCXRO8909
RR RUEHCN RUEHVC
DE RUEHGH #0534/01 2360835
ZNR UUUUU ZZH
R 240835Z AUG 07
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6171
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHNSC/WHITE HOUSE NATIONAL SECURITY COUNCIL WASH DC
RUEHGH/AMCONSUL SHANGHAI 6621

UNCLAS SECTION 01 OF 03 SHANGHAI 000534 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR EXEC - TSMITH, OASIA/ISA 
TREASURY FOR WRIGHT AND AMB HOLMER 
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN 
STATE FOR EAP/CM 
USDOC FOR 4420 
NSC FOR MCCORMICK AND TONG 
STATE PASS USTR FOR STRATFORD 
STATE PASS CEA 
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON; SAN FRANCISCO 
FRB FOR CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK 
 
E.O. 12958: N/A 
TAGS: EFIN EINV ECON CH
SUBJECT: SHANGHAI STOCK EXCHANGE BREAKS THROUGH 5,000 
 
REF: A. SHANGHAI 332 
     ¶B. SHANGHAI 325 
     ¶C. HONG KONG 2183 
 
SHANGHAI 00000534  001.2 OF 003 
 
 
(U) This cable is sensitive but unclassified and for official 
use only.  Not for distribution outside of USG channels or via 
the internet. 
 
¶1. (SBU) Summary: The Shanghai Stock Exchange's Composite Index 
(SCI) rose above the "psychologically significant" 5,000 point 
level for the first time on August 23, closing at 5,032.  The 
market has risen 80 percent since the beginning of 2007, adding 
to the 130 percent gain in 2006.  The SCI ended July 2007 at a 
record 4441 points and gained 591 points -- 13 percent -- in the 
past three and one-half weeks.  Consulate contacts almost 
uniformly remained bullish on the market and were confident that 
market fundamentals support the 5,000 points level.  Recent 
regulations granting Chinese investors increasing freedom to 
invest overseas, particularly in Hong Kong, would be more 
significant in the long-term since expected RMB appreciation and 
gains in Chinese markets makes keeping money at home more 
attractive in the near-term.  Market analysts did not anticipate 
any moves by the central government aimed specifically at 
reducing heating in the stock market, but noted that 
macro-economic measures designed to address inflation and 
sectoral overheating might affect the markets.  End summary. 
 
--------------------------------- 
Market Fundamentals Support 5,000 
--------------------------------- 
 
¶2. (SBU) Lombarda China Fund Manager Ian Midgely (Ref A) told 
Econoff on August 24 that the 5,000 level was a "psychologically 
significant barrier," but one that is clearly supported by the 
underlying market fundamentals.  The fundamentals are sound. 
Efforts over the past few years to restructure the companies 
that are listed on the exchange are now paying off with "quite 
spectacular profit results."  "This is also the first time I 
have seen Chinese companies put the interests of its 
shareholders first.  They are starting to look more like Western 
companies," he said. 
 
¶3. (SBU) Midgely expected in the short term to see some 
volatility, and even a temporary correction back to as low as 
4,000 points.  However, he would "be very surprised" if the 
market did not close above 5,000 points at the end of this year. 
 Furthermore, he believed that the market would be up an 
additional 50 percent in 2008.  "Look," he said, "I know that 
this sounds crazy if you think about the market starting out at 
1,000 points last year.  In China, it takes a long time to get 
things started, but the companies have taken the hard steps to 
restructure.  This is what is driving investors.  It takes 
things a long time to get started in China, but once the process 
gets up to speed it just keeps going.  China has for years been 
so far behind where they should have been that these gains just 
make sense," he said. 
 
¶4. (SBU) According to Midgley, policy makers are not concerned 
by rising stock market levels.  The stamp tax increase on May 29 
(Ref B) reflected their concerns about the churning effect and 
unpredictability caused by speculators "stir-frying" their 
accounts.  Raising the prices of trades was "exactly the right 
thing to do" as it dampened the numbers of small trades and 
encouraged investors to pour their money into mutual funds. 
With fund managers accounting for more and more of the trading 
volume, policy makers have increased confidence in the 
rationality of the market.  "It is better to let fund managers 
drive the market," he said. 
 
¶5. (SBU) Another reason Midgely did not expect policy makers to 
issue any "massive or draconian" measures to cool the market was 
the upcoming IPOs of such important companies as China Mobile, 
China Petroleum and the China Construction Bank.  (Note: In a 
separate conversation on August 24, Shanghai Stock Exchange 
(SSE) Deputy Director Chao Kejian said that the China Mobile IPO 
on the SSE would be delayed due to resistance from Hong Kong 
Stock Exchange's leaders who were concerned about maintaining 
Hong Kong's special role.  End note.) 
 
 
SHANGHAI 00000534  002.2 OF 003 
 
 
¶6. (SBU) The August 20 announcement by the State Administration 
of Foreign Exchange that Chinese citizens would be allowed to 
invest in overseas markets through a special trading account at 
the Bank of China Tianjin Branch, meant that over the long term 
the values of companies listed both in Shanghai and Hong Kong 
would come together.  (Note: There are some companies that are 
traded both in Hong Kong and Shanghai.  Given the 
limited-convertibility of the RMB and other financial 
restrictions, there have been wide P/E differences between 
shares prices of the same company.  End note.)  In the short- to 
medium-term, however, Midgely did not expect that arbitrage 
would actually be as easy as reported since structural 
impediments remain.  He did not expect that P/E rations on the 
Hong Kong exchange would rise to 30-40 and did not expect that 
the P/E of these companies traded in Shanghai would fall to 20. 
(Ref C) 
 
----------------------------- 
SSE: 5,000 -- Not a Big Event 
----------------------------- 
 
¶7. (SBU) Shanghai Stock Exchange Deputy Director Chao Kejian 
said, on August 24, that the SSE management was not viewing the 
crossing of the 5,000 point line as a "big event."  "We don't 
think that this is very meaningful."  Chao said that the 
recently released mid-year corporate balance sheets showed 
companies listed on the SSE averaged profits over 50 percent. 
 
¶8. (SBU) Chao said that if profits continued to be strong, SSE 
price to earnings (P/E) ratios would fall from the 50s range to 
33 by the end of the year.  The key issue for continued growth 
was that China's economic environment continues to be conducive 
to economic growth and expansion.  These macro-economic 
questions were dependent on whether or not the central 
government would tighten economic controls or fiscal policy. 
The overheated real estate market and heavy industry sector had 
policy makers "worried" he said.  They might take steps to cool 
off those sectors and this could lead to declines on the stock 
market.  Interest rate increases by the People's Bank of China 
were aimed at inflation and not at the market, he said. 
 
¶9. (SBU) SSE internal forecasts were for the market to rise to 
5,500 or 6,000 by the end of the year.  Chao was optimistic 
about market sentiment given the expected IPOs of such quality 
companies as China Petroleum, the China Construction Bank, the 
Bank of Beijing and other big companies.  Given the political 
sensitivity of the next couple of months as China holds the 17th 
Party Congress, Chao did not expect any major policy changes 
that would affect market stability. 
 
--------------------------------------------- ------------ 
Will Access to Overseas Markets Trigger a Crash in China? 
--------------------------------------------- ------------ 
 
¶10. (SBU) Industrial Securities Research Analyst Shi Hong told 
Econ Assistant on August 24, that since China's macroeconomic 
situation remained unchanged with continued excess liquidity and 
ongoing RMB appreciation, the current stock market "bubble" 
appeared to be "very sustainable."  Shi expected that the market 
would reach 6,000 points by the end of the year.  He expected 
that the central government would continue to tighten monetary 
policy by raising interest rates and bank required reserve 
ratios, but it was "highly unlikely" that it would take any 
steps directly aimed at the market such as the May 30th stamp 
duty increase.  It was the central government's aim to maintain 
a "Harmonious Society" among the retail investors.  This meant 
that the government wanted to avoid getting blamed for any 
negative outcomes from its policy, he said. 
 
¶11. (SBU) In the long-term, Shi said, allowing Chinese investors 
to purchase stocks freely overseas might trigger a crash in the 
Chinese markets.  "Maybe when we look back ten years from now, 
the trigger to an A-share market crash will be fully tradable 
H-shares by regular residents," he said.  Shi asserted that the 
SSE is a "policy market," controlled by the central government 
and subject to political tinkering.  In contrast, Hong Kong's 
stock market and other markets around the world are free from 
political control.  Once investors are free to invest in 
 
SHANGHAI 00000534  003.2 OF 003 
 
 
whatever markets they want to, should the central government 
take any "harsh" steps to rein in China's markets, investors 
will flee overseas (or to Hong Kong).  Investors have confidence 
that Hong Kong's exchange is free and driven by market forces 
rather than politics.  Nevertheless, given the current 
environment of RMB appreciation and massive gains, investors 
found the SSE a more attractive market at this current time. 
 
--------------------------------- 
The Bulls are Running in Shanghai 
--------------------------------- 
 
¶12. (U) Other consulate contacts expressed the following views 
on August 24: 
 
¶13. (SBU) CITIC Fund Management Company Senior Vice President 
for Business Development Peng Yan said that the market will 
continue to advance due to investor confidence.  In the 
short-term, she expected that both individual and institutional 
investors will pour new money into the market.  New mutual fund 
launches will also cause market advances since they are forced 
to purchase stocks despite their high prices.  Should the 
government issue policies aimed at contracting the market, she 
anticipated that the market would respond with a drop as sharp 
as the recent gains. 
 
¶14. (SBU) Deutsche Bank Research Associate Hong Tianfeng Hong 
noted that while 5,000 points sounded like a high number, over 
60 percent of stocks were still below their May 30 level, 
pre-stamp tax increase, level.  Hong believed that this left 
"limited room for a market correction." 
 
¶15. (SBU) Haitong Securities Company Director Wu Bing said that 
"there was too much money in the market."  This excess 
liquidity, combined with recent company profit statements, was 
what had pushed the markets up.  Like other analysts, he 
expected that the SSE's high P/E ratios would decline as these 
profits continued to grow.  For example, while the banking 
sector, the SSE's largest sector (REF Shanghai 478), has a high 
P/E ratio, the growth rate of banks' profits has been at least 
30 percent.  Since this growth rate was expected to continue for 
the next two to three years, its current high P/E ratio was not 
actually representative of reality and "quite acceptable." 
 
¶16. (SBU) Shenyin & Wanguo Securities Company Li Qinghai said 
that over-liquidity in the market would continue pushing up the 
market.  High returns from the equity market were attracting 
more capital into the stock market.  She noted that August 23's 
gains came after yet another PBOC interest rate hike.  While 
there might be some adjustments, Li was extremely bullish on 
future market performance. 
 
¶17. (SBU) Guotai Junan Research Analyst Kevin Luo said that the 
market was unlikely to experience a significant dip despite the 
"stretched valuation" at 5000 points.  Luo said that that the 
market was being sustained by the increasing number of new 
investors bringing new money.  "On the other hand, as a primary 
research brokerage house, we no longer see any more under-valued 
stock picks," he said.  It was Guotai Junan's house view that 
the A-share and H-share price difference would narrow from the 
current 60 percent to 20 percent in the next two years. 
JARRETT