Tuesday, February 1, 2011

Cheap but no one wants to make the first move

(Blommberg)Chinese stock valuations have tumbled to a record low compared with Hong Kong, a sign to investors that mainland equities are poised to rally even as the government cracks down on inflation.

The MSCI China Index’s 9.2 percent slump since November has left it trading at 11.7 times estimated profit for 2011, data compiled by Bloomberg show. The MSCI Hong Kong Index rallied 26 percent between July and December, beating China shares by the most in nine years and pushing its valuation to 17.5 times earnings, the highest ever compared with shares on the mainland.

Prudential Financial Inc. and USAA Investment Management Co. say the gap will close because economic growth may average 9.6 percent over the next two years, double the global figure in International Monetary Fund data. Premium valuations in Hong Kong, the route to China for most investors, signal that seven increases in bank reserves and two interest rate boosts by Wen Jiabao’s government since 2010 won’t derail growth, they say.

“Things will be all right even as China takes steps to tighten,” said John Praveen, the Newark, New Jersey-based chief investment strategist at Prudential International Investments Advisers, which oversees $750 billion. “Chinese growth will still be good.”

The global recovery is boosting demand for Chinese goods even as the nation takes steps to cool expansion in what likely became the world’s second-largest economy last year. China exported $283.3 billion to the U.S. in 2010, according to customs bureau figures released on Jan. 10. Gross domestic product in the U.S. grew at a 3.2 percent annual rate in the fourth quarter, up from 2.6 percent during the previous three months, the Commerce Department said Jan. 28.

Fivefold Surge

The last time Chinese stocks were this cheap relative to Hong Kong, in June 2004, the MSCI China Index was almost two months into a 3 1/2-year bull market. The measure increased fivefold and the earnings multiple climbed to 31 from 12.5, data compiled by Bloomberg show. At the time, the U.S. Federal Reserve was preparing to raise interest rates from 1 percent, a record low until policy makers cut their target for overnight loans between banks to near-zero at the end of 2008.

The MSCI China, a measure of mainland companies available to foreign investors, has retreated since Nov. 8 as regulators stepped up efforts to reduce inflation. The country’s policy makers increased the minimum down payment for second-home purchases and told local governments to set price targets on new properties, according to a Jan. 27 State Council statement.

The MSCI China fell for a third day, losing 0.2 percent to 66.43, while the index of Hong Kong shares slumped 1.2 percent to 11,412.12 for the biggest decline in more than a month.

Consumer Prices

Chinese consumer prices increased 5.1 percent in November, the fastest pace in 28 months, and 4.6 percent in December compared with the previous year, according to data from the statistics bureau.

“We have to wait and see what will happen to inflation,” said Terrace Chum, the Hong Kong-based managing director of greater China equities for Manulife Asset Management, which oversees $118 billion. “The Chinese companies look very cheap to me, but nobody wants to be the first to get in.”

Global investors are bracing for a financial crisis in China, with 45 percent saying they expect one within five years and another 40 percent anticipating a meltdown after 2016, according to a quarterly poll of 1,000 Bloomberg customers who are investors, traders or analysts. Only 7 percent said China will indefinitely escape turmoil, based on the survey that was conducted Jan. 21-24.

China Stocks Lagging

Hong Kong companies are beating Chinese equities again this year. The city’s shares have climbed 3.2 percent, while the MSCI China is unchanged for 2011. Speculation that Beijing policy makers will boost interest rates again drove the MSCI Hong Kong down 0.9 percent to 11,549.30 last week and the China gauge to a 1.2 percent loss to 66.59.

The MSCI All-Country World Index fell for a second week, dropping 0.2 percent to 334.54, as Egyptian protesters clashed with police. The gauge has rallied 94 percent since March 9, 2009, as the global economy recovered from the U.S. mortgage crisis that caused $1.98 trillion in bank losses and writedowns. Annual increases of 32 percent in 2009 and 10 percent last year were the biggest since gains of 32 percent and 13 percent in 2003 and 2004, data compiled by Bloomberg show.

“Global growth is fine,” said Madelynn Matlock, who helps oversee $13.8 billion at Huntington Asset Advisors in Cincinnati. “The liquidity from developed countries is helpful. The test that the Chinese policy makers face is probably a little tough. They have to find a way to keep the economy growing, without overheating. The good news is that they’ve done a good job so far.”

Less Than India

Consumer prices rose less in China than India last year, increasing 3.3 percent versus 10.8 percent, as both economies expanded at similar rates, according to data compiled by Bloomberg. GDP grew 10.3 percent last year in China and more than 8 percent in each of the first three quarters in India, according to government data. China’s GDP probably exceeded Japan’s last year, Economic and Fiscal Policy Minister Kaoru Yosano told reporters in Tokyo on Jan. 20.

PetroChina Co., the nation’s biggest energy producer, has risen 17 percent in the past six months as the Beijing-based company benefited from the 15 percent increase in crude oil prices last year. Its price-earnings ratio using 2010 income was 13.3 at the end of last week, compared with 13.9 for Irving, Texas-based Exxon Mobil Corp.

China Petroleum & Chemical Corp. of Beijing, the nation’s biggest oil refiner, advanced 33 percent since July 27. Energy stocks in the MSCI China trade at an average of 12.1 times estimated earnings, the lowest among 10 industries.

Biggest Gains

Companies that benefit from global growth are posting the biggest gains. Rising demand from emerging and developed nations led the IMF to raise its forecast for worldwide economic growth this year to 4.4 percent from 4.2 percent, according to a Jan. 25 report from the Washington-based lender.

Hutchison Whampoa Ltd., the world’s biggest container- terminal operator, has rallied 84 percent, leading industrial shares to the biggest gain among 10 groups in the MSCI Hong Kong in the past six months as rising exports helped drive expansion. The valuation for the company controlled by Li Ka-shing, Hong Kong’s richest person, has more than doubled from a two-year low of 13.7 times annual earnings in July to 26.8, according to Bloomberg data.

While the pace of China’s growth will slow in the next five years, the economy need not contract, said Aaron Gurwitz, chief investment officer at Barclays Wealth, which oversees about $244 billion. Gurwitz, who spoke in a Bloomberg Television interview, is bullish on Asian shares, including China, Korea and Taiwan.

Discounted Valuations

The MSCI China trades at 11.7 times estimated profits, below the average of 14.9, according to data compiled by Bloomberg since 2006. Among the 10 biggest global equity markets, only France, the U.K. and Germany have lower valuations. Gross domestic product in the European Union is estimated to rise 1.6 percent this year, the median estimate from 20 economists surveyed by Bloomberg. GDP in China will climb 9.6 percent this year and 9.5 percent in 2012, according to the IMF.

“The valuation disparity will probably return to normal,” said Wasif Latif, vice president of equity investments at USAA Investment Management Co., which oversees $47 billion in San Antonio. Chinese regulators “are trying to engineer a soft landing-type of situation and they will probably be able to manage that,” he said. “That would make for a decent buying opportunity.”

My very short commnents
I know that we have a lot of concerns out there, property bubble, inflation, macro-slow down, etc...... but if 10-11X PE(market as a whole) have not discounted all these bad news, what else will?

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