Shanghai Market Resilience A Good Sign for China Stocks

Gene Linn |

Shanghai Stock MarketThursday’s nice gain by China stocks in Hong Kong – on the heels of Wednesday’s big loss – is part of a volatile downward trend that emerged when the U.S. debt downgrade and other U.S. and European concerns took control of global markets. But one analyst sees signs that positive China trends could soon drive a sustained rally in China stocks.

One intriguing sign is that shares on Mainland markets are solidly outperforming global stocks, according to Eric Yuen, head of research at Guoco Capital. Many Chinese companies that have A-shares in Shanghai and Shenzhen also list H-shares in Hong Kong. Others have established companies in Hong Kong that are listed there – so-called Red Chips.

Links in prices between A and H-shares are not direct because they sell to different client bases. Chinese markets are mostly closed to outsiders, and mainlanders have very limited access to Hong Kong and other global markets.

FOLLOWING SHANGHAI

But Yuen told Equities: “Sooner or later the Hong Kong market will follow Shanghai instead of the U.S.”

One strong indication Shanghai will lead Hong Kong higher is that China’s inflation-fighting monetary tightening appears to be near an end, Yuen said. There’s a good chance figures will show that inflation peaked in July. And Chinese money supply growth is now below the government target.

“Further tightening by China is very unlikely,” Yuen said. “Another interest rate hike is very unlikely.”

Another positive trend is the on-going release of robust earnings announcements by companies on the Hong Kong market. Earnings growth has been 17%, according to Yuen, above the original forecast of 15%.

‘UNUSUAL VALUATION’

Underlying the chances for a sustained rally is the fact that the August swoon has driven Hong Kong valuations to near-historic lows of about 10X 2011 earnings.

“For example, most Chinese banks are trading at 6-7X PE with dividend yields of 5%,” Yuen said. He acknowledged there are concerns about the banks’ asset quality because they may have to take on significant local government debts. Still, the valuations are eye-catching.

“The Bank of China is selling at 1X its book value,” Yuen said. “This valuation is really unusual. It offers good opportunities for long-term investors.” End

DAILY FIX -- China Companies Show Strong Profits

Hong Kong Blue Chips: +286, +1.5%, to 19,752, 08-25-11, Hang Seng Index

Chinese Stocks in Hong Kong: +175, +1.7% to 10,430, 08-25-11, HSCE Index

Shanghai Stocks: +2.9%, 2,615, 08-25-11, Shanghai Composite Index.

Chinese Stocks in the U.S.: -3.1 to 399.9, 08-23-2011, Bank of New York Mellon, ADR Index-China

Insight: Better-than-expected results by Chinese companies propelled Hong Kong higher. But weak turnover was dominated short-term traders as many investors waited to see if the U.S. Federal Reserve Board would announce measures to stimulate the economy at its meeting Friday. Bank of China (BHKLY) rose 5.8%, and oil producer CNOOC (CEO) gained 2.9%. KGI Research

Quotable: "As the investors worried (about) the asset quality and earnings performance, the financial sector is likely to lag behind the market." Haitong Securities. 8-25-2011

Chinese Company to Watch: Dongfang Electric (DNGFF) "China in the first half of 2011 repeatedly suffered the power shortage, which lifted the demand of coal plants and gas power, hydropower electrical equipment with higher efficiency. Although the growth of the nuclear power slowed, China still needs a great deal of energy to bolster the high-speed growth, which benefits the Company’s outlook." CFSG. 8-25-2011

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

Companies

Symbol Name Price Change % Volume
CEO CNOOC Limited 123.23 4.33 3.64 160,932
T.BNS Bank of Nova Scotia (The) 70.77 0.68 0.97 2,095,525

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