HONG HAO has seen this movie before, and it didn’t end well for China’s stock market bulls.

    Five months after an equity boom built on weak corporate profits turned into a US$5 trillion crash, a similar scenario is playing out in China today. The benchmark Shanghai Composite Index has surged 20 percent from its Aug. 26 low, despite third-quarter profits that trailed analyst estimates at 68 percent of companies in the index, the eighth straight quarter of disappointing results.

    The absence of a rebound in earnings is one reason why Hong, the chief China strategist at Bocom International Holdings Co., says the latest surge in stocks is a “bear market rally.”

    Foreign investors seem to agree: they’ve been selling mainland equities through the Shanghai-Hong Kong exchange link for four straight weeks, cutting holdings by the most in two months Thursday.

    “It’s very difficult to see this rally sustaining without an earnings recovery,” said Tony Chu, a Hong Kong-based money manager at RS Investment Management Co., which oversees about US$18 billion. Foreign investors “don’t have a very strong medium-to-longer-term view.”

    The rally in China follows an unprecedented government campaign to prop up share prices, along with increased monetary stimulus to combat the deepest economic slowdown in 25 years. The official support has helped revive confidence among local investors, spurring a pick-up in trading activity.

    The US$1.6 trillion recovery in Chinese share prices is also boosting valuations as earnings shrink. Trailing 12-month profits at Shanghai Composite companies have dropped 10 percent so far this year, leaving the index with a price-to-earnings ratio of 18. While that is still below the multiple of 25 reached at the height of the boom in June, it’s about 38 percent more expensive than the five-year average.

    The last time lower-than-estimated earnings from Shanghai Composite companies were this widespread, in the first three months of 2012, the benchmark gauge fell for the following two quarters.

    “China’s bull market can’t go long without earnings improvement, and so far there has been no improvement,” said Chen Li, a China equity strategist at Credit Suisse Group AG.

    “It is still a bubble. It is liquidity and not earnings driven. There has been no change in fundamentals,” Chen said.

    Of course, Chinese stocks have rallied before in the face of disappointing earnings. The Shanghai Composite’s record rally earlier this year came after 2014 profits missed estimates by the most in six years.

    In a market where individual investors account for more than 80 percent of trading, speculation often trumps fundamental analysis.

    Yao Lina, a 35-year-old accountant at a food company in Shanghai, says she’s bullish on stocks amid expectations that China’s new five-year plan for the economy will revive investor confidence.

    For Sam Le Cornu, who oversees about US$3 billion in Asian equities at Macquarie Investment Management in Hong Kong, liquidity is now a more important driver of the China’s stock market than profits.

    The People’s Bank of China cut its benchmark one-year interest rate for the sixth time in a year Oct. 24. The reduction was combined with a relaxation of lenders’ reserve requirements — a move analysts estimate released around 650 billion yuan (US$102 billion) into the banking system — and the scrapping of a ceiling on deposit rates.

    “Corporate earnings are not the focus at the moment,” Le Cornu said. “It has all to do with the central bank and its monetary policy.”

    (SD-Agencies)