China Developers, Small Caps May Weigh on Stocks, Jefferies Says

Chinese stocks face “challenges” this year because the government is unlikely to ease measures to stem inflation even as global economic growth slows, said Jefferies Group Inc.’s head of Hong Kong and China Research.

Investors should be cautious on the nation’s property developers as sales may worsen in the next two months, while small-company shares are more vulnerable than their larger peers to a global downturn, said Christie Ju who joined the U.S. investment bank in Hong Kong in January. Ju previously helped Bank of America Corp.’s brokerage unit take the top spots in Institutional Investor’s inaugural All-China Research Team poll and AsiaMoney’s survey of analysts.

“We are very positive on the longer-term outlook, especially given that valuation is very reasonable,” Ju said in a phone interview yesterday. “But for the next couple of months or even the first half of next year, we are in quite a bit of a challenging situation and lots of uncertainty.”

The Hang Seng China Enterprises Index of Chinese companies available to foreign investors has plunged 17 percent this year amid speculation the government will maintain policies to cool inflation. The gauge is valued at 9 times reported profit and reached the lowest level since November 2008 last month, according to data compiled by Bloomberg. The Shanghai Composite Index has slumped 10 percent in 2011.

“Inflation hasn’t really come down as significantly as people expected,” Ju said. “Right now we are still in the tightening cycle. It’s difficult to count on a general loosening cycle such as interest-rate cut and I don’t see that happening in the near term.”

Monetary Policy

The central bank has raised interest rates five times and ordered lenders to set aside more cash as deposit reserves 12 times since the start of 2010 to tame inflation, which jumped to a three-year high of 6.5 percent in July. Consumer-price gains may have slowed to 6.2 percent last month, according to the median estimate of 26 economists surveyed by Bloomberg News. August inflation data are scheduled to be released tomorrow.

China International Capital Corp., Asia’s biggest investment bank, said in a report this week that the probability of looser monetary policies faded after Premier Wen Jiabao wrote in the Communist Party’s magazine that inflation was his economic policy priority.

Societe Generale SA raised its rating on Chinese companies listed in Hong Kong last week to “overweight” on speculation the nation will stop tightening monetary policy. Chinese shares are pricing in a global recession and concern that regulators will boost policies to curb inflation through the end of the year, which is “illogical and fallacious,” according to the note from Societe Generale’s Todd Martin and Anthony Lee that’s dated Sept. 2.

Property Concerns

Jefferies’s Ju said Chinese property stocks haven’t “priced in” the possibility that sales in September and October will worsen amid tighter liquidity.

“We are seeing sales starting to decline and mortgage quotas are getting limited,” Ju said. “The situation has not improved, but worsened in the past couple of weeks.”

China Vanke Co., the nation’s biggest listed property developer, said sales dropped 13 percent in August from a year ago while Beijing Capital Land Ltd. said its contracted sales fell 43 percent last month. A gauge of 34 property stocks on the Shanghai Composite has dropped 1.4 percent this year.

UBS AG, Morgan Stanley and Deutsche Bank AG have lowered their economic growth forecasts for China for next year, saying the slowdown in developed countries will sap demand for the nation’s exports. The world’s second-largest economy grew 9.5 percent in the second quarter, slowing from a 9.7 percent expansion the previous quarter.

Small-Cap Stocks

Chinese small-capitalization stocks may extend their declines given the global economic outlook, Ju said. A ChiNext index of start-up companies has tumbled 21 percent this year on concern monetary tightening will make it more difficult for small companies to borrow from banks and expand businesses.

“Small caps don’t weather the downturn as much as their larger counterparts and the outlook for small caps is very challenging,” Ju said.

Ju recommended Chinese consumer-related stocks such as meat supplier China Yurun Food Group Ltd. and China Mengniu Dairy Co. because their earnings growth will better weather the slowdown in the economy.

“China’s going to pay for structural changes of the economy from more export-driven to domestic consumption-driven,” she said. “This is probably a period of time that’s extremely challenging for the global economy.”

— With assistance by Shidong Zhang

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