Gloomy data to slow bullish drive?

All this prompted the authorities to try to damp down speculation. The China Securities Regulatory Commission, which regulates the stock market, moved on April 17 to prohibit margin trading within so-called umbrella trusts, through which investors can borrow money to invest in shares.

It also announced on the same day after the markets closed that it would give the green light to short-selling (allowing investors to make money out of a falling market), which some saw as an attempt to take the froth off the market.

The moves came a day after the chairman of the commission, Xiao Gang, said investors should "fully evaluate risk in stock market investment", which was interpreted by some media as him reasserting a Newton's law principle that what goes up must come down.

Zhu at the Shanghai Advanced Institute of Finance believes the government is not entirely uncomfortable with a rising stock market so long as it does not overheat.

He believes the April 20 move by the People's Bank of China, the central bank, to cut the reserve requirement ratio by 100 basis points－increasing liquidity in the economy, some of which inevitably will end up in shares－reflects that.

But why is all this happening, while the economy is going through a painful period of restructuring, moving toward being more consumption-and services-led than relying on manufacturing and exports?

Recent precedents

It is certainly not without recent precedents. Western markets behaved similarly in the aftermath of the global financial crisis when stock markets soaked much of the money circulating as a result of quantitative easing, particularly since interest rates on deposits were near zero.

Tian at Aberdeen senses there has been a disconnect between the real economy and the Chinese stock market for some time.

"I think it has always been there. GDP growth hasn't necessarily been reflected in the market. I think what triggered this particular upturn was the government's decision to lower interest rates in the second half of last year. That really turned sentiment around."

Chen Xingdong, chief China strategist at BNP Paribas, based in Beijing, said: "China's real economic performance has not only been lackluster, but is deteriorating. This isn't deterring vast swaths of investors, however, who seem happy to ignore China's poor economic data.

He made the remarks on April 13, when China's General Administration of Customs reported a 15 percent drop in exports in March compared with the previous year and the Shanghai Composite Index rose by 2.1 percent the same day.

What is alarming some observers are the valuations of some of Chinese smaller companies listed on ChiNext, China's equivalent of the Nasdaq. Some are trading with price-to-earnings ratios, or PE, of more than 100 times.

Hao Hong, chief China strategist of Bocom International Holdings in Hong Kong, says it is the high values of the smaller companies that cause the most concern.

"The composition of the market is very different from the last time the market peaked, and that fell because then you don't have a very large representation of small caps.

"I would say the PEs of the larger caps are quite reasonable but the ChiNext ones are quite hefty," he said.

"Another big difference from the last time the market fell is that the stock market size is now some 40 trillion yuan ($6.45 trillion) plus, compared with 8 trillion when it was last at its peak. So you need five times as much money to push the market up."

Gary Liu, executive director of CEIBS Lujiazui Institute of International Finance in Shanghai, agrees it is difficult to make comparisons with the last time the market crashed.

"When we try to work out whether this is a bubble or not we cannot compare it with the past peak, that is not fair. The right way to measure the bubble is to simply look at the price earnings ratios, and you have to be concerned about companies on the ChiNext trading at more than 100 times earnings."

One of the factors behind the rise in the Shanghai Composite Index was the launch in November of the Stock Connect between Hong Kong and Shanghai, which has allowed global investors greater access to buy shares on the Shanghai market.

They could previously only invest through QFII (Qualified Foreign Institutional Investors) and RQFII (Renminbi Qualified Foreign Institutional Investors) quotas. These have also been recently relaxed.

"The reason for the gap in price was the restrictions in the quota with foreign investors needing a QFII quota," adds Tian at Aberdeen.

"If you look at the fundamentals, the shares are exactly the same but they are just listed in different places. This has been one of the factors in the rise of the Shanghai market."

The launch of Stock Connect has also created a "southbound channel" where mainland investors can invest more freely in Hong Kong. The Hang Seng Index closed 2.7 percent up on a single day on April 9, reaching 26,944.39, its highest level in seven years.

"The Connect channel has certainly been a key driver of positive sentiment in Hong Kong, and it has been very liquidity driven, which is essentially what you are seeing also on the mainland," Tian says.

"The underlying fundamental problem is that within the mainland investment opportunities remain fairly limited, whereas you have so many asset classes in Hong Kong. Until recently you have had all this money trapped in the mainland."

All this is likely to create opportunities for institutions and professional investors because whatever the medium-term trajectory there will be short-term ups and downs as the market overshoots and undershoots as a result of this wild investor behavior. These are interesting times and a clearer picture of the eventual trajectory could begin to emerge this week.