Oxstones Investment Club™By Michael Patterson and Allen Wan,
China’s fourth interest-rate increase in less than six months is spurring investment strategists at four of the world’s biggest banks to say it’s time to buy stocks in the fastest-growing major economy.
Credit Suisse Group AG boosted its 12-month forecast for the Hang Seng China Enterprises Index, also known as the H-share index, predicting a 28 percent gain after the central bank raised its one-year lending rate by a quarter point to 6.31 percent on April 5. HSBC Holdings Plc (HSBA) increased its rating on China to “overweight,” while Macquarie Group Ltd. (MQG) said investors should lift holdings. Citigroup Inc. (C) advised buying options to bet on gains.
The recommendations, which follow bullish forecasts last month from Goldman Sachs Group Inc. (GS) and Deutsche Bank AG (DBK), signal confidence that Premier Wen Jiabao’s government will curb the fastest inflation since 2008 without derailing growth in an economy forecast by the World Bank to expand 9 percent in 2011. The price-earnings ratio of the H-share index is 19 percent below its five-year average after profits surged 32 percent last year, beating analysts’ estimates, data compiled by Bloomberg show.
“I normally don’t go along with the brokers but this time they are right,” Sandy Mehta, the Hong Kong-based chief investment officer for Value Investment Principals and a former fund manager at Putnam Investments LLC, said in an interview yesterday. “China has been pro-active in raising rates to fight inflation. Stocks are also extraordinarily cheap.”
China Underperforms
The gauge of 40 Chinese companies listed in Hong Kong, known as the H-share index, has climbed 0.9 percent since the People’s Bank of China began raising interest rates in October, trailing a 9.9 percent gain in the MSCI Emerging Markets Index. When China’s borrowing costs increased a similar amount from October 2004 through March 2007, the index jumped 113 percent.
The measure is valued at 13 times earnings, a 4 percent discount to the MSCI emerging-markets index, according to data compiled by Bloomberg. That compares with an average premium of 13 percent for the index during the past five years, the data show.
Industrial & Commercial Bank of China (1398) Ltd., the nation’s largest lender by market value, increased per-share earnings 29 percent in 2010 from a year earlier while PetroChina Co., the country’s biggest oil producer, said profit jumped 36 percent, according to data compiled by Bloomberg. Anhui Conch Cement Co., the largest cement maker, posted a 76 percent gain in earnings last year.
Beating Estimates
“Overall results of Chinese companies were stronger than we expected,” Vincent Chan, a Hong Kong-based analyst at Credit Suisse, Switzerland’s second-biggest bank, wrote in a report dated April 6. Chan increased his 12-month estimate for the H- share index to 17,500 from 16,000 and boosted his forecast for the Shanghai Composite Index of mainland-listed equities to 3,650 from 3,600.
The H-share index rose less than 0.1 percent to 13,652.92 at the 4 p.m. close today, while the Shanghai Composite climbed 0.7 percent to 3,030.02 and the MSCI emerging-market index gained 0.4 percent to 1,206.59 as of 4:27 p.m. Hong Kong time. The iShares FTSE China 25 Index Fund (FXI) retreated 0.2 percent yesterday as an earthquake shook Japan less than a month after the nation’s worst temblor on record.
“As long as the central bank isn’t behind the curve, rate increases can be positive for equities because they show policy makers think economic growth is robust,” Garry Evans, the Hong Kong-based strategist at HSBC, Europe’s largest bank, said in an interview yesterday. He had been “cautious” on Chinese stocks for more than a year.
Inflation
China has increased its benchmark lending rate by 1 percentage point since October and lifted banks’ reserve requirements three times this year to tackle inflation and curb real-estate speculation.
Consumer prices jumped 4.9 percent in February from a year earlier, topping the government’s full-year target of 4 percent. Inflation probably accelerated to 5.2 percent in March, which would be the highest level since July 2008, according to the median estimate in a Bloomberg News survey of 23 economists. The statistics bureau will release the number on April 15, according to a preliminary schedule.
Policy makers will lift the key lending rate to 6.56 percent by year-end, according to the median forecast in a Bloomberg News survey of 20 economists on March 22. Besides monetary tools, the government has deployed subsidies, state- food reserves and the threat of price controls to counter inflation, which Premier Wen has described as a potential threat to social stability in the nation of 1.3 billion people.
Manufacturing Gains
This week’s rate increase “gets us close enough to the end of China’s late tightening cycle to mitigate a key policy overhang,” Michael Kurtz, a strategist in Hong Kong at Macquarie, Australia’s largest investment bank, wrote in an April 6 report. He upgraded Chinese stocks to “market-weight” from “underweight.”
Growth in Chinese manufacturing is a sign the economy may be weathering tighter policy. The Purchasing Managers’ Index rose for the first time in four months in March, climbing to 53.4 from 52.2 in February, the China Federation of Logistics and Purchasing said on April 1.
“We expect the Chinese government to engineer a soft landing of the economy,” Adrian Mowat and Frank Li, Hong Kong- based strategists at JPMorgan Chase & Co. (JPM), the second-biggest U.S. bank by assets, wrote in an April 5 report. They lifted their recommendation on Chinese stocks to “neutral” from “underweight” for Asian equity portfolios.
Fuel Prices
Strategists are too bullish because inflation is unlikely to slow any time soon, according to Zhao Zifeng, who helps oversee about $10 billion at China International Fund Management Co. in Shanghai.
China raised retail fuel prices this week for the second time this year after oil’s advance to a 30-month high undermined the government’s efforts to cap costs. A United Nations gauge of food prices is within 3 percent of a record high and may rise further after grains surged on reports of shrinking stockpiles, according to the UN.
“I don’t think there will be a bullish trend on China’s stocks,” Zhao said in an interview. “The whole year will be a fluctuating pattern.”
Daniel Lam, a Hong Kong-based strategist at Citigroup, the third-largest U.S. bank by assets, recommended buying three- month call options on the Hang Seng China Enterprises Index to profit from a rally. The contracts give the right to buy a security for a certain amount by a set date.
‘Overweight’ China
Chinese stocks were upgraded to “overweight” from “market weight” last week by analysts Helen Zhu and Timothy Moe at Goldman Sachs, the fifth-biggest U.S. bank by assets. They recommended banking and property shares and kept their 12- month target of 16,500 for the H-share index. Jun Ma, Hong Kong- based strategist at Deutsche Bank, Germany’s biggest lender, said in a report distributed March 21 that Chinese shares may climb about 25 percent.
“These hikes have been priced in,” Citigroup’s Lam wrote in an April 6 report. “China is trading cheap.”
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