China Stocks: The Shrinking Year-end Rally

Gene Linn |

These days the light at the end of the tunnel for China stocks is a little dimmer. But it could still shine on healthy profits for investors who have good timing.

For months one of the most common and comforting assumptions by analysts in Hong Kong has been that China stocks would surge from the doldrums in a major rally late this year. But recently experts pushed back the time of arrival of the upsurge and scaled back their year-end targets. But they say a rally is still on.

CCB International, the brokerage arm of China Construction Bank (CICHY), in early September dropped its prediction for Hong Kong’s Hang Seng Index at the end of 2011 from 26,000 to 23,000, according to CCBI head of research, Peter So. The Index, which includes numerous big Chinese companies, closed at 18,011 on September 28.

KGI Asia’s year-end prediction of about 25,000 fell to 22,500 to 23,000 at the same time. “That is in line with major brokerages,” Ben Kwong, chief operating officer at KGI, said at the time. “They had forecast 27,000 to 28,000, but have revised that to 23,000 to 24,000.”

Something that hasn’t changed since mid-year is the rationale behind the rally. China stocks valuations are low -- big banks have PE ratios in the single digits – because Chinese authorities have repeatedly increased interest rates and boosted banks’ required reserve ratios since late last year to fight inflation. The tightening moves slowed economic growth, which weighed on stocks.

The relentless fight against inflation will turn the tide and allow China to stop tightening monetary policy and start loosening, the reasoning goes. Then investors will pile in to snap up cheap Chinese stocks.

What has changed since late August, though, is emergence of political gridlock in the U.S. and the growing possibility of Greek debt default and a global recession.

And the market free-fall from September 19 to 23 further shook confidence in the scope of the year-end rally. CCBI, for now, maintains its 23,000 target. “We are still optimistic that solutions will be found by the U.S. and Europe to tackle their problems,” said So on Monday. “If that doesn’t happen it will be a negative surprise, and we will downgrade our prediction.”

KGI, however, reduced its prediction from about 23,000 to 20,000. Last Friday Kwong cited “mounting fear of the worsening of Euro debt crisis and the global economic slowdown” for the downgrade. He told Equities that China stocks might stage a “moderate year-end rally.”

But So pointed out that although year-end targets have shrunk, big gains might still be intact for investors who have good timing. In July the forecast was that the Hang Seng would rise from about 22,000 at the time to 26,000 by 2012, some 4,000 points. Now the Index might rise to only 23,000, but that is a jump of about 5,000 points above current levels.

With growth coming from a lower base, the percentage increase could be bigger now -- 28% from 18,000 to 23,000 versus 18% from 22,000 to 26,000.

Despite the drop in the end-of-the-year target, So said: “The upside is similar, but the whole framework is lower.”
Investors who bought stocks when the Index was at 22,000 will see little gain if 2012 starts with the Hang Seng at about 23,000. But if they jump in now at 18,000 or so, profits might exceed those of investors in Wall Street.

Kwong and So think the rally will arrive in November or December; earlier predictions by some analysts put the upturn in August or thereabouts. The main reason for the delay is stubbornness of Chinese inflation.

Instead of gradually peaking as early as June as some observers expected, inflation surged from 5.5% in May to 6.4% in June and rose to 6.5% in July. Inflation dropped to 6.2% in August, still too high to please investors. They are especially careful about taking on more risk due to increased worries about European debt and a possible global recession.

Inflation rates will finally become acceptable in November and December, according to Kwong, partly because they will be measured from high levels in the same months the year before.

When – and if -- the rally comes, So said investors would move out of defensive stocks they are sheltering in now such as telecoms and utilities. Among new investor targets will be companies in what China considers to be strategic industries. According to So, the government will announce new policies in the next two months to promote new energy, biotechnology and other cutting-edge companies. End

DAILY FIX -- Commodity Producers Gain

Hong Kong Blue Chips: -119, -0.7%, to 18,011, 09-28-11, Hang Seng Index

Chinese Stocks in Hong Kong: -17, -0.2% to 9,277, 09-28-11, HSCE Index

Shanghai Stocks: -1.0%, 2,392, 09-28-11, Shanghai Composite Index.

Chinese Stocks in the U.S.: +2.6 to 361.3, 09-27-11, Bank of New York Mellon, ADR Index-China

Insight: Hong Kong opened lower after Tuesday's sharp rise and retreated further in the early afternoon in line with a drop in Asian and Mainland Chinese markets but gained back some losses before closing. Higher commodity prices helped Chinese resources plays. Oil producer CNOOC (CEO) gained 3.9%. Cement producers and construction companies continued to rebound: CNBM (CBUMY) +3.4%. KGI Research

Quotable: "Market rebound may continue but confidence remains weak." BOCOM International. 9-27-11
Chinese Company to Watch: China properties. "Considering current market volatility, we suggest sticking to index composite stocks with high market liquidity and with developers with healthy balance sheets. According to this criteria, we recommend CR Land (1109)" CCB International. 9-26-11

Brokerages and analysts cited have disclaimers on their websites emphasizing their statements are for information only. They do not endorse my blog, and I don't endorse them.

For a list of Chinese companies sold in the U.S. and information on each company go to http://www.adrbnymellon.com/dr_country_profile.jsp?country=CN

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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Symbol Name Price Change % Volume
TNPRD Tsakos Energy Navigation Ltd n/a n/a n/a 0

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