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HSBC Recommends Avoiding China Stocks Until Second Half 2011

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HSBC Recommends Avoiding Stocks Until Second Half 2011
The central bank has boosted reserve requirements eight times since the start of last year, while increasing interest rates three times. Photographer: Nelson Ching/Bloomberg

Feb. 21 (Bloomberg) -- HSBC Holdings Plc recommended investors avoid China’s stocks until at least June because the government will announce more policy measures to cool inflation.

“We wouldn’t advise buying equities until we’re clear of signs of inflationary pressure and that probably won’t happen until the second half,” Garry Evans, a strategist at HSBC in Hong Kong, said in a Feb. 18 phone interview after the central bank ordered lenders to set aside more money as reserves for the second time this year. “We have been pretty cautious on Chinese equities for a year now and we still think there is a risk of more increases in reserve requirements and interest rates.”

The People’s Bank of China announced following the close of markets on Feb. 18 that reserve ratios will increase half a percentage point from Feb. 24, draining cash from the financial system after lending surged in January, inflation quickened and new home prices rose in all but two of 70 cities monitored by the government. The central bank has boosted reserve requirements eight times since the start of last year, while increasing interest rates three times.

The Shanghai Composite Index has rebounded 4.4 percent this year, after sliding 14 percent in 2010, amid speculation the Chinese economy will withstand the tightening measures. The measure gained 1.1 percent to 2,932.25 at the 3 p.m. close today, erasing an earlier decline of as much as 0.5 percent.

Nomura Holdings Inc., ranked first by Institutional Investor magazine in its All-China Research Team poll last year, turned “bullish” on China’s stocks on Feb. 15, citing “inexpensive” valuations and growth in money supply. The Shanghai Composite’s 930 companies trade at an average 18.5 times reported earnings, compared with an historical average of 34.5 times since 1990, quarterly data compiled by Bloomberg show.

Limited Reaction

Even with a 0.9 percent drop on Feb. 18, the Shanghai Composite gained 2.6 percent last week, the most since the five days to Nov. 5, as exports in January exceeded estimates. The Standard & Poor’s 500 Index and iShares FTSE China 25 Index Fund, an exchange-traded fund that holds Chinese stocks, both ended 0.2 percent higher after the China reserve-ratio increase. The Bank of New York Mellon China ADR Index slipped 0.1 percent.

“Markets have whispered about this RRR hike since yesterday, so the RRR hike is not a surprise,” Ting Lu, an economist at Bank of America Corp.’s Merrill Lynch unit wrote in a Feb. 18 report. The effect “should be quite small.”

The Shanghai Composite dropped 1.3 percent on Jan. 14, before the last increase in reserve requirements was announced. The gauge has risen 3.9 percent since then.

The government will increase interest rates at least four more times this year, causing the rally in stocks to falter, Andy Xie, an independent economist who previously worked for Morgan Stanley, said in a phone interview on Feb. 18.

‘Inflation Challenge’

‘It will be difficult for the market to go higher as the government seeks to reduce liquidity,” Xie said. “China is facing a huge inflation challenge.”

Zhou Xiaochuan, the nation’s central bank governor, said reserve requirements are just one tool to curb price gains in the fastest-growing major economy.

“We can’t really say that it’s the only method that we’ll use to battle inflation, it’s about using all means including rates and currency,” he said in a Feb. 18 interview. “One method doesn’t exclude the other,” said Zhou, who was attending a Group of 20 nations summit in Paris.

China’s inflation accelerated to a 4.9 percent annual pace in January, exceeding the government’s 2011 target for a fourth month. Banks extended 1.04 trillion yuan ($158 billion) of new loans, more than double December’s level, according to central bank data on Feb. 15.

HSBC’s Evans expects inflationary pressure to ease in the latter part of the year, spurring gains for the nation’s stocks.

“We could have a strong rally,” he said.

To contact Bloomberg News staff for this story: Allen Wan in Shanghai at awan3@bloomberg.net.

To contact the editor responsible for this story: Darren Boey at dboey@bloomberg.net.

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