All Those China Stock Bears Give SocGen More Reasons to Buy

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Societe Generale SA’s Vivek Misra says bears are getting it all wrong on the Chinese stock market.

While pessimists focus on surging price-to-earnings ratios, SocGen’s Asia equity strategist says what matters most is China’s improving long-term outlook for profits and dividends. Bears fret over the slowing economy, yet Misra sees shares gaining even if growth falls to a 15-year low of 6 percent. Mainland equities will join MSCI Inc. indexes, he says, despite opponents who worry about increased state intervention.

Misra, who predicted the surge in Chinese stocks in the second half of last year, is among a small but vocal group of international strategists sticking with their bullish calls after a $4 trillion rout sent foreign investors to the exits. The SocGen forecaster says the Shanghai Composite Index will rally 40 percent by the end of 2016, joining counterparts at Goldman Sachs Group Inc. and JPMorgan Chase & Co. who predict a recovery in the world’s second-biggest stock market.

“Chinese shares have the potential to re-rate,” Misra said by phone from Bengaluru, formerly known as Bangalore.

Investors who use price-to-earnings ratios to value Chinese shares aren’t giving enough weight to future growth in profits and shareholder payouts, according to Misra.

While the median trailing price-to-earnings ratio on mainland bourses is 65, higher than in any of the world’s 10 largest markets, SocGen predicts profits for Shanghai-listed companies will grow at least 10 percent annually through 2017 as firms distribute about 29 percent of their earnings via dividends. That makes mainland shares look cheap versus peers, based on SocGen’s estimate of equity risk premiums across Asia.

Reserve Ratios

The Shanghai Composite fell 1.65 percent today, following a 3.7 percent gain on Tuesday.

China’s economic slowdown will spur authorities to increase monetary stimulus, which is positive for stocks, Misra said. The central bank will eventually cut reserve requirement ratios for lenders to 10.5 percent from the current level of 18.5 percent, he said.

While China’s second-quarter economic growth of 7 percent was in line with the government’s annual target, signs of a deeper slowdown emerged in July as a private gauge of manufacturing sank to a two-year low.

“You could see, over a number of years, the required reserve ratios being reduced, which is a powerful tool,” Misra said. “That could result in the overall market going up.”

Foreign Outflows

So far, the bear case is gaining more traction with international investors, who sold almost $8 billion of Shanghai shares via the city’s exchange link in the past four weeks. They’ve also increased bets against the biggest U.S. exchange-traded fund tracking mainland stocks to near record levels.

Within China, the weekly number of new stock investors has declined to the smallest since the government started releasing figures in May. Wagers on equities using borrowed money have dropped to a five-month low.

“Investors are still in a panic after the stocks rout,” said Wei Wei, an analyst at Huaxi Securities Co. in Shanghai. “They are not willing to pile into the market to buy at this stage.”

While pessimists say China’s efforts to prop up share prices have undermined its pledge to boost the role of markets, Misra says some of the measures -- in particular the injection of state funds into shares -- were necessary to restore stability.

Policy makers have also banned major shareholders from cutting stakes, curbed short selling, restricted futures transactions and allowed hundreds of companies to halt trading in their shares.

The intervention is unlikely to prevent China’s $6.4 trillion mainland market from gaining acceptance in MSCI’s global indexes within two years, a step that could lure as much as $57 billion of inflows from passive funds, according to Misra.

China’s stock market is “simply too big to ignore,” he said.

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