MARKET OUTLOOK
The Federal Reserve’s new round of quantitative easing is expected to bring U.S. dollar under pressure over the next six months and increase risks of global inflation and asset bubbles in the long run. China has recently raised its key
interest rate for the first time since 2007 in order to combat inflation and rising
property prices. This move reflected a turning point of China’s monetary policy
and change in government’s top priority from “growth” to “inflation”. We expect to see more rate hikes in 2011 but the impact on stock market will be similar to the previous cycle in our view. During the period from April 2006 to October 2007, China lifted 1-year lending rate from 5.58% to 7.29% while the Shanghai SE Composite Index surged from approximately 1,400 to 6,000 and the Hang Seng Index (“HSI”) climbed from approximately 17,000 to 32,000. The possibility of a bull cycle for China and Hong Kong stock markets over the next 6 to 12 months is also supported by fundamental valuation. According to market estimates, the HSI(at 24,144)is now trading at 2010 PER of 15.3x which is close to the historical averages of 15.9x, 15.4x and 14.8x over the past 10, 20 and 30 years respectively.Obviously, current valuation of the HSI is not cheap but certainly not at a risky level. We maintain our year-end target for the HSI at 24,000-25,000 and believe the index would reach 28,000 in 2011. Any pull back should be viewed as a buying opportunity.
Chinese banking sector is our top favourite among H shares for the rest of the year because (i) third-quarter earnings of banks were largely above market expectations, (ii) further rate hikes will improve net interest margin resulting in earnings upgrade, (iii) current valuation of banks, trading at 2011 PER of 8.5x-13.0x or 10.1x on average, is still cheap by historical standard or compared with HSCEI.
Our top picks remains ICBC (1398) and CCB (939). On the other hand, we continue to take a cautious view on Chinese property stocks given unfavourable
government policies. However, those with robust property sales revenue and strong executive capability should deserve a positive re-rating such as Evergrande (3333). Our price target for Evergrande is $4.20.
Investors who prefer to trade laggards may consider the following stocks. Angang Steel’s (347) share price dropped 2% in October since the company recorded a loss in the third quarter. However, we expect earnings to make a sharp rebound in the fourth quarter amid a rise in steel price. Our price target for Angang Steel is $14.80.
SMIC (981), the largest semiconductor foundry in Mainland China, reported
better-than-expected third quarter earnings. We believe the counter deserves a positive re-rating with a price target of $0.75 based on P/B of 1.25x. New World Development (17), the smallest blue chip property company, is currently trading at a discount of 42% to NAV. Further increase in Hong Kong’s property prices will eventually trigger a re-rating of property stock with deep discount to NAV in our view. Our price target for New World Development is $19.60.