Photographer: Lam Yik Fei/Bloomberg

China H Shares Seen Extending World’s Best Rally as Profits Beat

  • JPMorgan predicts H-share index to gain a further 11% in 2016
  • Some 65% of companies on the gauge top earnings estimates

It’s not too late to buy into the bull run by Chinese stocks in Hong Kong.

That’s according to Adrian Mowat, the chief Asian and emerging-market equity strategist at JPMorgan Chase & Co., who predicts the Hang Seng China Enterprises Index will climb a further 11 percent by the end of the year. The benchmark gauge of mainland companies traded in the city jumped 8.8 percent in the month through Tuesday to beat all global indexes tracked by Bloomberg.

Mowat said investors are still too downbeat on the nation’s equities given better-than-estimated profits by companies most exposed to swings in economic growth. Some 65 percent of stocks on the Hang Seng China Enterprises Index beat expectations in the first half of the year, the best performance since 2012. Even after the rebound, the gauge trades at an earnings multiple 60 percent lower than the global average.

“There’s too much pessimism around China," said Mowat, the Hong Kong-based strategist who turned bullish on the nation’s equities in April. “If you look at the profit numbers we’re beginning to see the cyclical sectors beat."

The gauge of so-called H shares has rebounded 32 percent since reaching a seven-year low in February, when concern over China’s economic slowdown and heavy-handed state intervention in mainland financial markets had investors fleeing for the exits. The index, which is still 33 percent below last year’s peak in May, climbed 0.3 percent to a nine-month high on Wednesday.

Insurers were among companies topping forecasts with first-half earnings. Ping An Insurance (Group) Co. reported an 18 percent increase in net income as growth in premiums and banking revenue helped offset the impact of stock-market declines.

The earnings outlook for state-owned enterprises is still clouded. More than twice as many companies on the H-share index reported negative first-half growth than last year and the economic picture is subdued. Data on exports, industrial production and retail sales all fell short of economists’ estimates in July.

"We’re not saying that China doesn’t have any structural problems, but perhaps after the big fall we saw in the A share market last year and all the concerns on the yuan, investors’ level of anxiety is still a little bit too high," Mowat said. The H-share index has climbed about 12 percent since he raised his rating on Chinese stocks to overweight.

Relative Strength

Technical indicators suggest the Hang Seng China Enterprise’s rebound is at risk of overheating. The gauge’s 14-day relative strength index has climbed above the 70 level that signals to some traders gains are overdone. Ping An’s RSI has risen to 72.7, while that of Bank of Communication Co. is the highest in a decade.

Mowat’s forecasts haven’t always panned out in the past. He said last June that a slump in mainland shares would be a buying opportunity because of expected government support. The Shanghai Composite Index fell more than 30 percent in the next two months.

Still, he’s not alone in seeing an extended rally in H shares. Deutsche Bank AG is also bullish, predicting in a note last week that profit growth by non-financial companies will accelerate in the second half, prompting analysts to raise their estimates.

“If you get profits, you’ve got a little bit less of a risk premium and China does well," Mowat said. “So I’m upbeat about that."

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