It was a surprise indeed when the Shanghai Composite Index began to reach record highs in the second half of 2006. Intrigued by the burgeoning stock market and potential benefits, more people began opening new accounts in securities trading departments, which were much busier than in the first half of 2006.

Guotai Jun'an Securities has seen people waiting in queues at its new account registration counter.

"After the stock market became bullish in 2006, this long queue is a common sight," said Zhang Weiguo, a stock buyer.

As a matter of fact, 2006 was a banner year for many aspects of the Chinese market. After more than a year of stagnation, Shanghai and Shenzhen stock markets began to launch initial public offerings (IPOs) again in June 2006, with the number reaching 70 at the end of the year, bringing in a total of 164.26 billion yuan.

Meanwhile, as the market matures, securities companies are beginning to log profits. Listed companies are able to pay down debts. Additionally, the successful issuance of warrants and the withdrawal of trial warrants of Baosteel Group and Wuhan Iron and Steel (Group) Corp. contributed to more mature stock, securities and futures markets.

Zhang said he started to trade stocks in 1996, and 2006 was the most profitable year for him.

"In 2006, the return on investment of my stocks has surpassed 200 percent," Zhang said. According to China Securities Journal, about 70 percent of investors made a profit in the bullish 2006 stock market.

But will this trend continue in 2007?

Zhang thinks so.

"I believe 2007 is also a bull year and all of my friends who buy stocks agree with me," Zhang said. What's more, Zhang said some of them have sold a part of their fixed assets and are going to invest the money in the stock market.

The question is: Will the stock market respond positively to buyers' passion?

A 20-percent increase?

"Generally speaking, the stock market will remain bullish in 2007," according to China and World Economic Development Report 2007, issued by the Chinese Academy of Social Sciences (CASS). "The A share market still has development potential and the Shanghai Composite Index will likely hit new record highs."

The CASS report explained that macro-economic development will provide a sound basis for stock market development. In 2007, China's national economy will sustain rapid and steady development, with the growth of GDP expected to exceed 9 percent. The CASS report holds that the world stock market will remain optimistic, with major stock markets keeping the momentum of growth, providing a sound external environment for the development of the domestic A share market.

Currently, the evaluation of listed companies is reasonable. By the end of September 2006, the price to earnings ratio (P/E ratio) of companies listed in the A share market was about 22, while the P/E ratio of companies in the Shanghai and Shenzhen 300 Index and Shanghai 50 Index was no more than 20. This suggests that listed companies are not overvalued. On the other hand, the revenue of listed companies will likely increase by about 20 percent in 2007. Therefore, if the current P/E ratio remains the same as that of 2006, Chinese stock markets can have the potential to develop 20 percent in 2007.

The rapid development of the Chinese stock market and the expectation that the renminbi will appreciate further should attract more capital to flow into the stock market, which will in turn push stock market development. Therefore, taking into account the sound business performance of listed companies, if the P/E ratio in the Chinese stock market increases 10 percent in 2007, the whole market will increase about 30 percent. It is estimated that the Shanghai Composite Index also will break the record highs of last year.

However, there are still some who doubt the bullish market prediction.

Hua Sheng, President of Yanjing Overseas Chinese University, pointed out that the surging 2006 stock market was resulted from multiple positive factors and that the prediction of the bullish market for 2007 is built upon the most ideal external environment.

Hua noted that many factors of the external environment are likely to change. For instance, the huge trade surplus will probably lead to more trade friction and could adversely affect the domestic economy at any time. The prices of international raw materials and precious metals have already peaked, and possible price falls may bring about structural adjustments. Meanwhile, rapid economic development is exposing serious problems including energy and resource depletion as well as environmental degradation. This calls for painful transformation of the current mode of economic growth.

Further, he warned investors, "Currently, there are much idle funds in the market. In fact, the financial crises in countries like Mexico and Thailand were largely caused by idle funds. We should always bear that in mind."

Finally, he pointed out that financial derivatives like futures will add uncertainty to the stock market.

Other experts disagreed with the CASS report, arguing that the listed companies are overvalued. On January 15, 2007, China Life Insurance Co. Ltd. closed at 43.45 yuan per share in the A share market with a 105.6 P/E ratio. Before China Life's astonishing performance, the stock price of the Industrial and Commercial Bank of China (ICBC) also reached 6.79 yuan per share on January 4 with a 56.58 P/E ratio. But the P/E ratio of Citibank was only 13.25 on that same day.

"The market is crazy and I don't know what to say," said Zhou Ming, an analyst with Guotai Jun'an Securities. "It is off track and it's obvious that institutional investors manipulated the market. I suggest small and middle investors should be cautious and let them play."

However, not everyone is as pessimistic.

"The market will remain bullish in 2007," said Gong Qiang, an analyst with China Merchants Securities. Gong argued that the most important element propelling the stock market rise is adequate capital. In the next two years or so, the expectation of renminbi appreciation will continue and more capital will flow into the Chinese market.

With regard to the overvalue of listed companies, Gong Qiang said, "There are some bubbles. But the P/E ratio of some other stocks like iron and steel and non-ferrous metals is still lingering around 10, which is a normal span and has room for future growth."

What should we buy?

Although experts and analysts are weighing the gains and losses, stock buyers have their own thoughts.

"If the experts cannot persuade me by concrete statistics and logic, I will keep buying stocks," said Zhang Weiguo. Zhang said that's because there are many stocks which he believes will be profitable.

Numerous people are investing in the stock market, hoping to get rich overnight.

But what can be bought that will most likely make a profit?

The CASS report predicted that in spite of a considerable rise of some A shares, the stock market in 2007 will have to undergo acute structural adjustment.

This conclusion by the CASS report is echoed by predictions of many securities companies. Zhou Ming stated that blue chips will lead the mainland stock market, the Hong Kong Stock Exchange and the futures market. He estimated 10 big blue chips will be listed in 2007 and will raise about 100-150 billion yuan.

Gong Qiang added that the market of 2007 will be different from that of last year. In 2006, nearly all stocks were on the rise, but in 2007 blue chips will grow significantly and small and incompetent stocks will be forced to step down.

Gong estimated that finance and communications would be two fast-growing industries in 2007 stimulated by the 2008 Olympic Games and the issuance of 3G licenses.

According to Gong, judging by the stock market performance of other Olympic hosting countries, before and after the Olympics, the stock market should continue to be bullish.

"Take the 1988 South Korean Olympic Games for example. That year, the South Korean stock market rose by 70.5 percent, and the overall increase rate from 1986 to 1988 was 462 percent," said Gong.

Li Junhua, an analyst with GF Securities Co. Ltd., said consumption, financial, engineering and manufacturing sectors, as well as industries with national features, will rise considerably.

While many investors are certainly enthusiastic, market management remains calm. Shang Fulin, Chairman of China Securities Regulatory Commission, pointed out that the optimization of capital market operation is more important than the rise or fall of the stock market.

Currently, futures development is imperative for the development of financial derivatives. Proper management of futures and other financial derivatives will propel the development of the stock market.

Just as many experts pointed out, it is of great importance to eliminate the structural and systematic barriers to build up a healthy and sustainable stock market.