Heading for a Big Bang?

When London-based Atlantis Investment Management launched a fund in medium-sized Chinese companies last March, the fund's size was a modest $15 million. Eleven months later, the stocks in its portfolio have doubled and the inflow of new money from eager investors has swelled its value to $116 million. "Europeans want to get exposure to what's happen-ing in China," says James Alexander, Atlantis' head of marketing. While the big jump in prices has made some investors wary, he says "there's still plenty of demand."

That may be the understatement of the year. Chinese stocks, particularly initial public offerings (IPOs), are the hottest investment of the moment. The index for "H shares," as the Hong Kong-listed stocks of mainland Chinese firms are called, spiked 152% in 2003. After three years of indifference to stocks during a bad bear market, many ordinary Hong Kongers are now giddy over just about any new offering with the word China attached to it, hoping to cash in by flipping shares within hours or days of buying them. The enthusiasm isn't just local: a lot of the interest is coming from Europe. More than half of the 89 Chinese stock funds easily available to European investors rose by at least 50% last year, and 19 were up more than 75%, according to the fund rating company Lipper. While nobody tracks how much new European money is flowing into these funds, all of them report strong demand.

Now that investors are back, Chinese companies are rushing to raise cash. This year will bring a bevy of highly anticipated IPOs, including Ping An Insurance, one of China's largest insurers, telecom company China Netcom Corp. and possibly China Construction Bank, one of the mainland's four largest banks. Accounting firm PricewaterhouseCoopers estimates that Chinese companies will raise $10 billion in IPOs in Hong Kong this year; about 50% more than in 2003.

The big question, of course, is whether the current boom will last, or whether Chinese stocks will simply prove to be the next bubble waiting to pop. Already, there are some ominous signs of irrational exuberance. For example, a firm called China Green Holdings, which began trading for the first time on Jan. 13, became the most popular IPO in Hong Kong history, with retail investors placing $4 billion worth of orders — or enough to buy 1,604 times more shares than the company had undertaken to sell. One investor was May Wong, a 50-year-old garment importer-exporter in Hong Kong. On the opening day of trading, she and about a dozen other investors gathered at a branch of brokerage KGI Asia in the city's North Point district shortly before 10 a.m. Within minutes of the starting bell, China Green shares had climbed 56%.

Wong quickly sold her holding of 3,000 shares for a gain of about $250 — small change, sure, but not a bad return in less than 30 minutes. "It's like a gift," she said gleefully. While investors behaved as if the company is destined to be a global titan, China Green — which grows cabbages and other produce and sells packaged vegetables — is still tiny. It has about 150 employees and reported just $31 million in revenues and $14 million in profits in its last fiscal year. Other signs of overheating: shares of China Life Insurance, the country's largest insurer, are up 56% since their Dec. 18 debut, while gold-mining company Fujian Zijin Mining Industry saw its stock price surge 73% in its first day of trading, Dec. 23.

In the short term, such suspension of disbelief can be highly profitable, but it can also be an excellent way of losing money fast. "Some of the investors will ultimately be burned," says Joseph Lau, a director at Tai Fook Asset Management.

Optimists point to China's bottomless labor pool and insatiable demand as evidence that this may not be a bubble at all; the Chinese economy is growing exponentially as a new middle class takes shape, they argue, and that should continue to drive stocks higher. Most of the companies going public are solid operations with proven track records, state backing and large market shares in well-understood industries — not Internet start-ups. The dotcoms "were selling a concept, but most of the companies listing in Hong Kong have a profit," says Kenny Tang, associate director of Tung Tai Securities.

Still, some international investors are growing cautious. "Some type of midcycle correction wouldn't be unexpected," says Alexander of Atlantis Investment. Yang Liu, who manages the Atlantis fund, warns that investors should stick to IPOs of big, stable companies that have solid earnings growth. "You have to be sure you know about the company and have done your homework," she says. In a sign of the dangers of investing in China, state auditors revealed in late January that they had found accounting irregularities at China Life, though the firm says that they occurred in 2002 at a predecessor company to the insurer, which underwent a reorganization last year. Still, says Alexander, "China has come a long way in five years. It's a much safer place to invest now." For the moment, at least, Hong Kongers — and a growing number of Europeans — appear to believe him.