China stocks to climb 65% in the coming year: Morgan Stanley

China, the worst-performing stock market after Greece, looks like a buy by almost any measure, according to top-ranked analysts of the Asian nation’s shares.

The Shanghai Composite Index’s 27 percent plunge this year, including yesterday’s 4.3 percent slump, sent its price-earnings ratio to 18, the lowest level versus the MSCI Emerging Markets Index in a decade. The largest owners of yuan-denominated stocks have turned net buyers for the first time since equities bottomed in 2008, while international investors are paying the biggest premium in 21 months to bet on a rally in funds that hold China’s yuan-denominated or A shares, data compiled by Macquarie Group Ltd. and Bloomberg show.

Morgan Stanley, BNP Paribas SA and Nomura Holdings Inc. say stocks will rally as China’s June 19 decision to end the yuan’s two-year peg to the dollar helps curb inflation and asset bubbles. The Shanghai index rose 62 percent in 12 months after China last allowed a more flexible exchange rate in July 2005.

“We are very bullish,” said Jerry Lou, the Hong Kong- based strategist at Morgan Stanley, among the top-ranked analysts for China stocks by Institutional Investor, who predicts the Shanghai Composite may climb 65 percent to 4,000 by June 2011. “We like valuations and inflation will peak. All we need is a catalyst such as a change in yuan policy.”

Prospects for a stock rebound may be cut as China’s exports face “strong headwinds” in the second half and loan growth may slow by the end of 2010, Citigroup Inc. said this week, even as the average of 14 economist estimates in a Bloomberg survey calls for economic growth of 10.2 percent this year and 9.2 percent in 2011.

Revision

The Conference Board yesterday revised its leading economic index for China, contributing to the biggest sell-off in Chinese equities in six weeks. Agricultural Bank of China Ltd., which priced the Shanghai portion of its $20.1 billion initial share sale, also drove banking stocks lower.

The Shanghai Composite fell for a sixth day today, losing 1.2 percent to 2,398.37 at the close. Its slump this year is second only to the 35 percent plunge in Greece’s ASE Index among the world’s 60 biggest stock markets, according to data compiled by Bloomberg. Companies on the Shanghai gauge will increase earnings by 40 percent in 12 months, more than double the pace of the ASE, analysts’ estimates by Bloomberg show.

Rising profits reduced the Shanghai Composite’s valuation premium over the MSCI emerging index to 26 percent, down from an average of 140 percent since 1997, based on weekly price- earnings ratios compiled by Bloomberg. The last time the gap was so small in February 2000, the Shanghai Composite gained 27 percent in 12 months, while the MSCI measure sank 26 percent.

Lower Valuations

Lower valuations spurred the biggest Chinese investors to buy last month. Shareholders who own at least 5 percent of a company’s stock boosted their holdings by 1.1 billion yuan ($162 million), according to Macquarie analysts Michael Kurtz and Shirley Zhao in Shanghai, basing their analysis on data from Wind Information. Similar purchases in October 2008 signaled the end of the Shanghai Composite’s year-long bear market, with the gauge rallying 82 percent from its low on Oct. 28, 2008, through October 2009.

Yuan-denominated shares, restricted almost exclusively to local investors, fell below Chinese stocks traded in Hong Kong this month for the first time in almost four years, according to the Hang Seng China AH Premium Index. When A shares last traded at a discount in November 2006, the Shanghai Composite tripled in 12 months, outpacing a 156 percent gain in the Hong Kong benchmark index and a 58 percent rise in the MSCI gauge.

‘Pay for Exposure’

“The premium between A and H shares is disappearing,” said Hao Hong, Beijing-based global equity strategist at China International Capital Corp., the top-ranked brokerage for China research in Asiamoney’s annual survey. That indicates “foreign investors are willing to pay for exposure to China’s stocks.”

International investors pushed the price of BlackRock Inc.’s iShares FTSE/Xinhua A50 China Index exchange-traded fund to 11 percent above the value of its underlying assets last week, the highest level in almost two years, according to data compiled by Bloomberg. The fund trades in Hong Kong and tracks the 50 biggest A-share companies.

The Shanghai Composite fell 23 percent this quarter, lagging behind gauges in the other so-called BRIC markets of the largest developing economies, after China raised banks’ reserve requirements to the highest level in at least three years and curbed real-estate speculation. Property prices rose 12.4 percent in May from a year earlier, the second-fastest pace after April’s 12.8 percent record gain.

BRIC Markets

Brazil’s Bovespa index dropped 12 percent during the period and Russia’s Micex slipped 8.7 percent, while India’s Bombay Stock Exchange Sensitive Index advanced 0.3 percent. The MSCI emerging gauge lost 8.9 percent.

The New York-based Conference Board corrected its April gauge for the outlook of China’s economy this week, saying its leading index for the country rose the least since November, rather than registering the biggest gain in 14 months.

A flood of new stock may also weigh on the market, according to Credit Suisse Group AG’s Sakthi Siva. Chinese companies will sell about 320 billion yuan ($47 billion) of new shares in Shanghai and Shenzhen this year as they fund expansion and banks bolster capital after a record amount of government- led lending, PricewaterhouseCoopers predicts.

Agricultural Bank’s share sale in Shanghai and Hong Kong is the biggest initial public offering since Industrial & Commercial Bank of China Ltd.’s $21.9 billion sale almost four years ago.

‘Quite Cautious’

“I’m still quite cautious,” Siva, the Singapore-based top-ranked Asia strategist in Institutional Investor’s 2010 poll, said in an interview. “There’s quite a lot of supply.”

Ending the fixed 6.83 yuan peg to the dollar should help “contain inflation and asset bubbles,” China’s central bank said in a June 20 statement. Inflation will probably peak at 3.7 percent toward the end of the third quarter then “level off” the rest of the year, according to CICC’s Hong.

Chinese authorities had prevented the currency from strengthening against the dollar since July 2008 to help exporters cope with the global financial crisis.

The yuan appreciated 21 percent in the three years after a managed float against a basket of currencies was introduced in 2005. Twelve-month non-deliverable forwards yesterday indicate investors are betting the yuan will strengthen 1.6 percent. A yuan revaluation won’t happen quickly or fix all of the global economy’s imbalances, International Monetary Fund Managing Director Dominique Strauss-Kahn said this week.

Vanke, China Merchants

China Vanke Co., the Shenzhen-based property developer that sank 37 percent this year, trades for 13 times reported profits, down from 35 times a year ago, according to data compiled by Bloomberg. Earnings growth of 29 percent this year will help lift the stock 42 percent, according to analyst estimates on Bloomberg.

China Merchants Bank Co.’s 2.7 price-to-book ratio is near a record low relative to the MSCI Emerging Markets Financials Index after the Shenzhen-based company declined 24 percent this year. The stock is poised to surge 49 percent in 12 months, according to analysts, who have 35 “buy” ratings and one “sell,” according to data compiled by Bloomberg.

Consumer-related shares will benefit from a shift in the economy to increase domestic spending, said Leo Gao, who helps oversee about $600 million at APS Asset Management Ltd. in Shanghai, whose APS China Alpha Fund has beaten 87 percent of peers in the past year, according to Bloomberg data.

“Stocks will end the year higher,” Gao said.