Bloomberg News

China Stocks Priced for Hard Landing Signal Rally to Brokers

June 27, 2011

(Updates stock-index performance in seventh paragraph.)

June 27 (Bloomberg) -- The lowest Chinese stock valuations since economic growth collapsed three years ago are a sign to the nation’s biggest brokerages that it’s time to buy.

The Shanghai Composite Index’s 6.2 percent retreat this quarter sent the gauge to 11.6 times estimated profit, data compiled by Bloomberg show. It took the global financial crisis and a decline in China’s growth rate to a seven-year low of 6.8 percent to push valuations this low in November 2008. The Shanghai gauge rebounded 49 percent in the next six months.

Citic Securities Co. and China International Capital Corp., which predicted the drop this quarter, say the market will rally in the second half as inflation peaks and the government sustains the economic expansion by easing credit. Even Nouriel Roubini, the New York University economist who says China may face a “hard landing” after 2013, expects growth of at least 8.8 percent in 2011 and 2012.

“The market has basically priced in a very pessimistic outlook for the economy,” said Ling Peng, chief strategist at Shanghai-based Shenyin & Wanguo Securities Co., ranked China’s most influential research provider by New Fortune magazine last year. “A hard landing of the economy is very unlikely,” he said, forecasting the Shanghai index will advance as much as 15 percent by the end of the year to about 3,150.

Government Control

The gauge of more than 900 stocks traded mostly by local investors has trailed the MSCI Emerging Markets Index by 1.5 percentage points this quarter as the People’s Bank of China raised lenders’ reserve requirements for the 12th time since the start of 2010 and increased benchmark interest rates for the fourth time. Tighter monetary policy has spurred a drop in loans, cut money supply growth to the slowest pace since 2008 and sent short-term borrowing rates to a three-year high.

The government is curbing credit to tame consumer prices that boosted inflation to 5.5 percent last month, the highest level since July 2008. Retail sales trailed estimates in the past two months as rising prices eroded the buying power of China’s 1.3 billion people.

The Shanghai index rallied 3.9 percent to 2,746.21 last week after Premier Wen Jiabao wrote in an opinion piece in the Financial Times that China’s efforts to stem inflation have worked and the pace of price increases will slow. The stocks gauge added 0.4 percent to 2,758.23 at the 3 p.m. close today.

Beijing-based Bank of China Ltd. climbed 5.2 percent last week to 3.25 yuan, still below Citic’s share-price estimate of 4 yuan, according to data compiled by Bloomberg. The lender has a price-to-book ratio 40 percent below its five-year average, the data show.

Growth Outlook

China Vanke Co., the country’s biggest developer, is valued at a 50 percent discount to MSCI’s gauge of global real estate companies, compared with a 10 percent discount two years ago, the data show. Shares of the Shenzhen-based company climbed 4.1 percent last week.

“The tightening that China has done for the last 18 months has been effective and seems to be coming towards an end,” said Philippe Langham, who runs the $855 million RBC Emerging Markets Fund from London. The government “still seems to have a large amount of control” over the economy, he said.

China’s expansion, which has averaged more than 10 percent during the past decade, may slow to 9.5 percent this year, according to the median estimate of 11 economists surveyed by Bloomberg. The outlook compares with projected global growth of 4.3 percent, according to June forecasts from the Washington- based International Monetary Fund.

Credit Concerns

Roubini, the co-founder of New York-based research firm Roubini Global Economics LLC who predicted the worldwide financial crisis, said in a June 11 interview that China’s reliance on exports and investment may spur “massive” non- performing loans and cause the expansion to falter after 2013.

Credit Suisse Group AG cut its earnings forecasts for Shanghai index companies and advised reducing bank holdings in a June 20 research report. A surge in “off-balance sheet” financing may force policy makers to clamp down on credit growth for longer than investors anticipate, according to Hong Kong- based analysts Vincent Chan and Peggy Chan. Chinese profits may increase 10 percent this year and next, weighed down by banks’ non-performing loans, the analysts wrote.

Roubini Global still sees Chinese growth of 9.1 percent this year and 8.8 percent next year, according to the firm’s web site. Credit Suisse predicts an expansion of 8.7 percent this year and 8.5 percent in 2012. The Zurich-based bank has a target of 3,000 for the Shanghai index.

‘Control the Risks’

“There are some underlying problems for the long term but the situation isn’t as bad as some investors’ forecast,” said Pan Jiang, a Shanghai-based money manager at Franklin Templeton Sealand Fund Management Co., which oversees the equivalent of more than $2.6 billion. “We shouldn’t underestimate the government’s insight into the situation and its power to control the risks.”

Shanghai index profits will jump 32 percent in the next 12 months, topping the 19 percent growth rate for the MSCI emerging-market index, according to the average of more than 14,000 analyst estimates compiled by Bloomberg.

The Communist Party is boosting investment in affordable housing to counter a slump in manufacturing growth to the slowest pace since August. Premier Wen set a target to build 36 million social housing units over the next five years, according to a Feb. 27 online interview.

Cheap Valuations

Citic Securities recommended shares of property developers and cement companies because of the government’s housing measures. China’s biggest brokerage, which turned “positive” on the nation’s stocks in a June 20 report after being “cautious” since April, has a six-month target of 3,500 for the Shanghai index.

The Chinese equity gauge is valued at a 32 percent discount to the average 12-month forward price-earnings ratio since January 2006, data compiled by Bloomberg show. The ratio touched 11.1 on June 20, the lowest level since Nov. 7, 2008. The measure’s price-to-book ratio slid to 2.2 times last week, the least since February 2009. That was three months after the Chinese government announced a 4 trillion yuan ($618 billion) stimulus plan to revive growth amid the worst global recession since World War II.

“China’s stocks are close to a bottom in terms of valuation so there is limited room below the current level,” said Mei Luwu, a Shenzhen-based fund manager at Lion Fund Management Co., which oversees more than $7.8 billion. “Valuations for some industries like banks are at bottom levels.”

‘Back Up the Truck’

The Shanghai gauge may rebound about 20 percent in the second half of the year, CICC wrote in a June 13 report. China’s largest investment bank and the top-ranked China research provider in Asiamoney magazine’s survey forecasts peak inflation of about 6 percent in June and 2011 growth of 9.2 percent.

Hao Hong, CICC’s Beijing-based global equity strategist who had been “cautious” on China’s stocks since mid-April, said industries that will benefit from a second-half equity rally include cement, machinery, non-ferrous metals, property and insurance.

“A slowdown has been fully priced-in,” he said. “Depressed valuation, sentiment and technical indicators all augur well for a budding tradable rally. Back up the truck.”

--Michael Patterson, Allen Wan, Shidong Zhang. With assistance from Irene Shen in Shanghai and Shamim Adam in Singapore. Editors: Bloomberg News, Laura Zelenko

To contact Bloomberg News staff for this story: Michael Patterson in London at mpatterson10@bloomberg.net.

To contact the editors responsible for this story: Darren Boey at dboey@bloomberg.net; Gavin Serkin at gserkin@bloomberg.net. undefined -0- Jun/27/2011 08:12 GMT


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