Chinese equities have more room for growth

With the Hang Seng Index surging past the 20,000 mark and closing at 20,624.54 points yesterday, CSOP Asset Management, the Hong Kong subsidiary of China Southern Fund Management proclaims that Hong Kong is the most attractive market with the best prospect for growth in the world.

Michael Wen, CIO at CSOP Asset Management, is hugely bullish about the investment outlook for both China-listed A-shares and Hong Kong-listed Chinese stocks.

Any further discussion about whether the V-shape recovery will succumb to a W-shaped correction is beyond the point at this time, he says. The economic recovery process has just kick-started and is certain to become more visible in the second half of the year, which bodes well for Chinese equities.

The Chinese government's policies, which have initiated the current recovery process, will remain the key driver dictating the direction of China's economic performance.

With the rate of M2 expansion in China already well exceeding the nation's GDP growth, there is no question the Chinese stock markets are already in positive bullish territory. Equities are now in a recovery phase and valuations have just come up to a historical average. With expected earnings growth factored in, price-to-earnings ratios could hardly make Chinese stocks expensive.

Liquidity, while abundant, is not a key driver for China and Hong Kong markets. Neither market has lacked liquidity even in the worst trough of the financial crisis. Rather, the corrections have been based on investor pessimism, which Wen says has been overstated.

Later in the year, he says more laggard economic indicators, such as electricity output in power plants (which only started picking up in June), will converge with the early indicators. As more statistics become available, a new round of analyst upgrades for Chinese stocks is on the horizon, and should help reinforce positive sentiment for both A-shares and Hong Kong-listed H-shares and red-chips.

In the domestic property market, developers' inventory is close to the bottom, and Wen says more property developers will miss out on the traditional peak season for new property sales in September to October. He says both state-owned and private real estate developers that he has been in touch with are very optimistic about property prices surging due to supply tension in the second half. The trend will likely feed back into the material and construction sectors.

Funding through local credit channels remains healthy. Chinese banks and corporates, unlike those in Western countries, are not at risk of over-gearing at this point. The China Banking Regulatory Commission has strict requirements that Chinese banks stay within a limit of 75% loan-to-saving ratio. (The industry average is in the mid-60s currently.)

Rather, there is a risk that Chinese banks will face thinning margins as a steeper yield curve may later emerge in China. The total size of Chinese corporates' indebtedness to bank loans is just about Rmb2 trillion ($256 billion), he notes. More companies have been able to diversify their funding source to include corporate bonds and commercial paper issuance.

He predicts new credit expansion will slow in the second half, as the market becomes saturated with new capital. In the first half, Chinese banks issued some Rmb7.3 trillion ($936 billion) worth of new loans. Wen believes the total new credit made in the whole year will round off to about Rmb10 trillion ($1.3 trillion). He notes the slowdown will be a natural process and should have little impact on sentiment for equities.

As the key offshore settlement centre for renminbi trades, Hong Kong will benefit from China's strengthening fiscal position. The engine for renminbi appreciation is just restarting. Over the long-term, the continued strengthening of the currency will help lift corporate earnings in Chinese firms listed in the city.

Wen says more Chinese investors are eyeing cheap valuations in Hong Kong-listed H-shares and red-chips, compared to what's available in mainland A-shares. CSOP is positive the Hong Kong equities market will receive a further boost from its plans to integrate with the economy in the Pearl Delta region.

Wen says it is unlikely that the Chinese government will make a significant departure from its policies to support the economy. However, policies are subject to change and the key risks to watch out for will be any mass-scale exit of capital from the market, or an out-of-control growth in property market prices, which will likely lead the government to start implementing tightening policies.

He says US Federal Reserve chairman Ben Bernanke has told the world how the Fed intends to exit the market, but not when. The timing is now closely monitored by investors. Until the US central bank starts making moves to tighten rates, however, it is unlikely that China will do so as well.