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Chinese Equities to Beat U.S. Stocks by 15%, Says Skandia

The big gains this year for equity investors will come from China, and not the U.S., as the world’s second-largest economy manages a soft landing with the help of easier credit and lower interest rates, according to Skandia Investment Group.

The Hang Seng China Enterprises Index of mainland stocks will rally 15 percentage points more than the Standard & Poor’s 500 Index, the U.S. benchmark, said Rupert Watson, the Southampton, England-based head of asset allocation at Skandia, which oversees about $13 billion. The gains will be more if the euro-area sovereign-debt crisis is contained, he said.

“We’re heavily overweight on Chinese stocks,” Watson said in a telephone interview. “We believe China is in the process of a soft landing. Economic growth will probably bottom in the second quarter, with stronger growth in the second half, supported by further loosening of monetary and fiscal policy. Favorable valuations are also positive for the stocks.”

The China Enterprise Index has trailed the S&P 500 by 9 percentage points so far this year, as investors concerned by the worsening debt crisis in Europe turned to U.S. stocks. The Chinese gauge has dropped 17 percent from its 2012 peak on Feb. 29, as the country’s first-quarter economic growth missed estimates and demand for its goods slid in Europe.

Stimulus Optimism

Chinese stocks have rallied 3.7 percent since June 7 when the People’s Bank of China cut benchmark lending and deposit rates for the first time since 2008. The S&P 500 has risen 3.3 percent during this period.

A quarterly central bank survey of 3,000 bankers in China, published on June 19, found that more than two-thirds of respondents considered the current monetary policy “appropriate.” Almost a third said monetary policy will be loosened next quarter, compared with 6.7 percent who said so in the previous survey.

“In China, the authorities have plenty of flexibility to loosen both monetary and fiscal policies to boost economic growth if that is necessary,” Watson said. “In contrast, interest rates and bond yields are at rock bottom levels in the U.S., while there is little or no scope to loosen fiscal policy.”

A purchasing managers’ index from HSBC Holdings Plc and Markit Economics gave a preliminary reading of 48.1 for June. Readings below 50 indicate contraction.

Companies on the Hang Seng China Enterprises Index traded at 7.67 times estimated earnings on average yesterday, compared with 13 times for the S&P 500 and 10.5 times for the Stoxx Europe 600 Index, according to data compiled by Bloomberg.

U.S. Outlook

The Federal Reserve reduced its benchmark interest rate almost to zero in December 2008 and later bought $2.3 trillion in securities to push longer-term borrowing costs lower. In January, it said it would keep rates near zero at least through late 2014. After the Fed announced a plan on Sept. 21 to extend the average maturity of the securities in its portfolio, the yield on the 10-year Treasury has fallen, reaching a record low 1.4387 percent on June 1.

The U.S. will face a so-called fiscal cliff at the end of 2012 when income tax breaks expire and about $1 trillion in automatic spending cuts take effect.

Watson has a neutral stance on European equities and is underweight on U.S. stocks.

American equities gained so far this year largely because investors turned skeptical of European shares amid surging borrowing costs for the region’s most-indebted nations and political uncertainty in Greece, Watson said. If the crisis abates, European markets will rebound more than other markets.

Global investors have increased their holdings in U.S. stocks to the third-highest level on record, a Bank of America Corp. survey showed on June 12. A net 31 percent of respondents said they were overweight on U.S. equities, up from 26 percent in May.

“We think too many investors are too bullish on the U.S. market and too bearish on the European one,” he said. “We think it’s dangerous to heavily underweight a market that everyone hates and where valuations are very cheap. Especially with sentiment on the euro zone at rock bottom, there is scope for European markets to outperform other developed markets if these very low expectations are beaten.”

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