Hang in there, and be selective. That is the path to making good money on China stocks this year, according to William Fong, investment director for Asia Pacific Equities at Baring Asset Management. He is also the lead manager of the Baring China Select Fund and Baring China Growth Fund.
There will be money to be made, he told Equities, because the pieces for a sustained rally are starting to fall into place compared to the dismal picture last autumn.
He sees three conditions that need to be met: better China macro-economic numbers, improvement in the European debt crisis, and a sustained rise in the A-share market on the mainland.
In the macro-economic field, Chinese inflation has fallen from a peak of 6.5% in July to 4.5% in January. Actually the January figure was an increase from December, but the consensus is that the rise was mainly due to the fact the long Chinese New Year holiday fell in January and that inflation will start falling again this month.
Another important development is that lower inflation brought about the start of a switch from credit tightening to credit loosening.
However, as a result of last year’s string of interest rate increases and rises in banks’ required reserve ratio, the Chinese economy is slowing. It will take some time before the current loosening will turn things around.
As for the European debt situation, Fong says it certainly won’t go away but, “The worst is over.”
China’s A-shares have underperformed stocks in global markets, according to Fong. “The Shanghai market is tricky,” he said. “It is dominated by retail investors who are very sensitive to government policies. When there is further credit loosening in the rest of the year, Shanghai will catch up.”
With improvement or prospects for improvement in all three key areas the stage is set for a bull market in China stocks.
But the bull will have to wait for a few months, Fong said. After surging 12% in January, Hong Kong’s Hang Seng Index stalled until jumping again February 15. But overall, Fong said, a consolidation will likely last for the first half of the year.
“When we talk to clients they are not the positioning for a China market rally,” he said. “They see the Chinese economy going down the first half of the year and then up in the second half.
“Some are waiting for a trough in China’s GDP, so the market will consolidate for awhile.”
When the consolidation is over and a sustained rally starts, investors can’t jump in with both feet.
“Last year when the European debt crisis hit, stocks moved down together,” Fong said. “Now in 2012 it will be more bottom-up. You need to be selective.”
A big reason stocks will not go up at the same rate is that China’s credit loosening will be selective because of a worry about a return of inflation. “China’s policy statement said they will follow a ‘prudent’ monetary policy,” Fong said.
That likely means there will not be frequent interest rate and required reserve ratio cuts. “The policy measures for easing will be quite selective and targeted,” Fong said. In other words, preferential treatment such as tax cuts will go to certain industries and sectors.
Here is where it gets tough. Foreign investors may have trouble getting information on targeting policy changes in a timely manner.
Fong declined to recommend individual stocks, but he said banks and properties should do well. They are now comparatively cheap, he said, and monetary loosening will make them even more attractive.
Barings will also continue to over-weight the info-technology sector because of booming sales of smart phones and tablets.
As for how high Chinese stocks will go once the big rally starts, Fong said: “We don’t give a concrete target, but the historical PE average is 12 to 13, and now even after a rally (in January) it is below 10. There is definitely an upside.” End
Hong Kong Blue Chips: -67, -0.3%, to 21,425, 02-20-12, Hang Seng Index
Chinese Stocks in Hong Kong: -42, -0.4%, to 11,670, 02-20-12, HSCE Index
Shanghai Stocks: +0.3% to 2,364, 02-20-12, Shanghai Composite Index.
Chinese Stocks in the U.S.: -0.6, 418.8, 02-17-12, Bank of New York Mellon, ADR Index-China
Insight: Hong Kong blue chips added to last weeks' sharp gain by opening 268 points higher after China cut banks' reserve requirement ratio but started to swoon in mid-morning under profit-taking pressure to end slightly lower in increased turnover. Downstream oil giant Sinopec (SNP) fell 5.4%. KGI Research
Quotable: "The HSI marked the seventh weekly gain this week, gaining more than 3,000 points so far in 2012, amid hope for loosening monetary conditions on the Mainland as well as gradual improvement in the US economy and the European debt crisis. The HK stock market is likely to take a breather very soon, as the blue-chip index moves closer to the key resistance area near 21,600-22,800." BEA Securities. 2-17-12
Chinese Company to watch: "We have raised our earnings forecasts for China Bluechem and China XLS Fertiliser. We rate the chemical fertilizer sector “Market Perform” and upgrade China Bluechem and China XLS Fertiliser from “Neutral” to “LT-Buy” and raise our TP on the two counters by 20.4%/22.1% to HK$7.90/HK$2.70, respectively." BOCOM International. 2-20-12
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