January 04,2011

15 Best China Stocks to Buy in the Year of Rabbit

By Hao Hong, CFA,Hong Kong

Buying Investable China and Hong Kong, but not for RMB, liquidity or QE:

We are buying, and we believe the MSCI China will reach 80, HSCEI 15,000 and HSI 29,000. Consensus is buying for RMB, QE2 and liquidity. We are not. Our research shows that strengthening expectation for RMB appreciation tends to correlate with lower forward return; fund flows into China and Hong Kong are close to the record high in Nov 2007, but is guided by return expectations and is at best a coincidental indicator; QE supports asset prices, but the market could stop even if QE is in place, as it had been between Nov 2009 and April 2010. We are not positive on any of the factors that have led the consensus to be bullish.

Instead, we have compared growth potential and valuation trends globally to evaluate under-valued growth opportunities. For a global portfolio manager, Investable China appears under-valued, especially when compared with its growth potential. China A-shares, especially large caps, B-shares, as well as other BRIC countries, are also attractive. But China small cap A-shares are very expensive. Risks to our view include policy risks in China, contagion from Europe and US economic relapses.

More bullish in 1H; buying cyclicals in 1H, adding consumer and healthcare in 2H:

China's industrial output growth is troughing, while inflation is likely to peak in 1Q11. Such milieu calls for a two-pronged investment strategy during 2011. Cyclicals, including basic materials, energy, industrials and real estate, tend to outperform when economic growth is rising while inflation pressure is high. Meanwhile, consumer sectors and healthcare appear overbought and expensive near term.

As inflation pressure subsides and economic growth is sustained from 2Q11, the outperformance of cyclicals is likely to start waning. At this point, investors should take some profits in cyclicals and start switching into more defensive sectors including staples, consumer discretionary and healthcare. This investment timeline coincides with the potential ending of QE2 around mid year. Further, cyclicals tend to take market leadership for the first two to three quarters of a rally, if history is a guide. If the current uptrend started around mid year 2010, then cyclicals should let more defensive sectors take the lead sometime during 2Q11.     

Top 20% of Americans critical to US recovery; China's economic fundamentals improving:

Both the US and China's economic fundamentals influence Investable China. The top 20% of Americans control 85% of the country's net worth and earn 61% of income. Further, the saving rate among this group is negative, while the unemployment rate of Americans with bachelor degrees or above, presumably high income earners, is at ~4%. High net worth, high income, negative savings rate and low unemployment make the top 20% of Americans critical for the US recovery. Indeed, the extension of the Bush tax cut probably has a more enduring effect on the US economy than QE2.

In China, the credit cycle is rising again, presaging troughing economic growth and peaking inflation. Further, our long-term China market sentiment indicator shows that the July low in 2010 is likely to be an important long-term bottom. If so, the current uptrend in both investable China and China A-shares should persist in 2011, although gains are likely to be larger in 1H11. Our sector analysts have picked 15 stocks for 2011 including :

Anhui Conch (914.HK, BUY),

Tencent (700.HK, BUY),

China Pacific Insurance (2601.HK, BUY),

Longfor Property (960.HK, BUY),

China Unicom (762.HK, BUY),

Haier Electronics (1169.HK, BUY),

Mengniu Dairy (2319. HK, BUY),

China Lilang (1234.HK, BUY),

Zhongsheng Group (881 HK,BUY),

Weigao Group (1066 HK, ACCUMULATE)

Comba Telecom Systems (2342.HK, BUY)

BJ Enterprise Water Group (371. HK, BUY)

GCL-POLY Engergy (3800.HK, ACCUMULATE)

Zhaojin Mining (1818.HK, ACCUMULATE)

Fushan Energy (639.HK,ACCUMULATE)

 (The author is a strategist at Global Strategy|Equity Research, CICC)

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