China's Stocks Will Rally on Government Support, Guotai Says

By Chua Kong Ho

Oct. 17 (Bloomberg) -- China's Shanghai Composite Index, down 69 percent from its record high a year ago, is poised to rally even as the deepening financial crisis hammers equities worldwide, the country's largest brokerage by assets predicts.

The Shanghai Composite Index will climb 88 percent to 3,600 points in the next 12 months as government measures to bolster economic growth take effect, said Zhang Xiuqi, Shanghai-based strategist at Guotai Junan Securities Co. in an interview. The index peaked at 6,092.06 on Oct. 16, 2007 and closed at 1,909.94 yesterday.

``The plunge in stock values this year has more than priced in a slowdown in China's economy and the impact of the global crisis,'' Zhang said in a telephone interview, calling his forecast ``conservative.'' He recommends investors favor bank, telecommunications and drug stocks.

China's stocks, the world's most expensive at their peak, are still pricier than U.S. and European shares after the credit freeze triggered a rout in global equities this month. China's government has cut interest rates twice and may boost spending to protect an economy that slowed for a fourth consecutive quarter in the three months through June.

Analysts including Zhang have remained bullish on Chinese equities even as the weakening economy deepened the market's one-year slump. There were ``buy'' ratings on 60 percent of the country's stocks in that time, Bloomberg data show.

Zhang said in April that ``fair value'' for the Shanghai Composite was at 3,300 points, 73 percent higher than yesterday's close. The gauge's average value in the second quarter was 3,318.80.

Skeptical Investors

Mark Konyn, Hong Kong-based chief executive officer at RCM Asia Pacific is skeptical that it's time to buy Chinese equities. The Shanghai Composite Index is valued at 13.7 times estimated earnings, more than 11.6 times for the Standard & Poor's 500 Index and 7.9 times for Europe's Dow Jones Stoxx 600 Index. The Shanghai measure was at 49.4 times at its peak a year ago.

``Confidence has been shattered and it's going to take time for that to come back,'' said Konyn, who is ``underweight'' equities. His company holds $15 billion of Asian assets.

Morgan Stanley said last month that investors should sell into a rally spurred by China's stock support measures as they are ``defense'' and don't mark a ``bottom for recovery.''

Zhang's bullish view is shared by Michael Hartnett, Merrill Lynch & Co.'s chief global emerging markets strategist, who upgraded Chinese shares to ``overweight'' Sept. 2, saying that ``pro-growth policies'' will ease the economic slowdown.

The People's Bank of China cut interest rates for the first time in six years last month and followed that with another reduction three weeks later as central banks around the world cut borrowing costs to unlock frozen credit markets. China's $200 billion sovereign wealth fund also increased its stakes in the largest state-backed banks to shore up investor confidence.

The government will probably cut borrowing costs further and lower bank reserve requirements, freeing up lending and ensuring that a decline in earnings growth will bottom in the second quarter of next year, said Guotai Junan's Zhang.

To contact the reporter responsible for this story: Chua Kong Ho in Shanghai at kchua6@bloomberg.net