Is China’s Stock Market Overvalued?

China’s stock market has soared in the past year and a half:

Even if you look at the market from 2000 and average in those down years through 2005, it’s still grown tremendously.

Nouriel Roubini argues forcefully that Chinese stocks are overvalued, with the PE around 50.  What to think?

1.  China has great growth prospects over the long haul.
2.  The Chinese economy will stumble some time.  I’m not forecasting when, but there’s no doubt that at some point they’ll have either a significant slowdown in growth or a real recession.  Heck, it’s hard for U.S. policymakers to avoid a recession, and we pretty much know what we’re doing. China is running on near-total ignorance of economics.
3.  China’s strong economic growth trend does not imply a stronger-than-average stock market.  When everyone knows China is growing at 10% real, then you have pay for stock at a price that incorporates what everyone else knows.

Should should a stock investor do about China?  Include Chinese exposure to your portfolio.  It’s good diversification.  If you want to overweight China, look for companies selling internally rather than externally.  That is, commodities sold on the global market (steel, aluminum, cement) are fiercely competitive.  However, there are still market imperfections in consumer products and services, so look there for investment picks.

But don’t get carried away with the momentum play.  It may work early in the cycle, but momentum investors always get burned when the market changes.