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Home  Story Archive 2008 GOLDMAN SACHS upgrades China to 'overweight'
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GOLDMAN SACHS upgrades China to 'overweight' |
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Thursday, 16 October 2008
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 Report dated Oct 14.
GOLDMAN SACHS believes the market decline and recent events in the global credit markets gives the Chinese equity market an attractive risk/reward, and has called for an ‘overweight’ on it.
China is trading at a discount to the region and the possibility of a large scale fiscal stimulus could positively influence both 2009 earnings and valuation, it said in a report dated Tuesday, Oct 14.
”Policy makers have moved to a more pro-growth stance in the last month, including two rate cuts.
"While a large fiscal stimulus package remains in the realm of speculation, we feel confident that policymakers are willing to use a wide variety of measures to avoid the effects of a global slowdown and avert a hard landing in China.”
Excerpts from the report on Goldman's reasons for the “overweight’ rating:
 source: Goldman Sachs report
1. Price: China has fallen more than other regional equity markets. Offshore China equities are down 28% since we last expressed a cautious view on Sep 9, even with a large rebound off recent lows. China onshore and offshore stocks have significantly underperformed the region year-to-date (down 62% and 52% vs. 43% for the MSCI Asia ex-Japan index) and since May’s bear rally highs.
2. Valuations: China’s valuations have compressed significantly in absolute and relative terms. Sharp share price declines and good underlying earnings growth have led to a significant reduction in equity valuations, in absolute terms and relative to both the region and the market’s historical ranges. HK-listed China equities currently trade at 8.6x consensus 12-month forward earnings and 1.76x trailing book value.These are -1.2 and -0.5 standard deviations from mean levels and an 8% discount and 10% premium respectively to the regional averages.
3. Policy: Initial moves towards a pro-growth stance. As recently as early September, China’s policy stance remained restrictive and oriented towards fighting inflation. Since then, monetary policy has eased, favorable A-share market measures have been announced and rural land reform measures have been discussed. Thus, policy appears to have shifted towards a pro-growth stance.
4. Earnings: Downside risks remain, but a more accommodative policy stance may cushion the extent to which profitability falls. We remain alert to the risks to 2009 EPS growth for China as well as for the rest of the region. However, 2009 estimates are becoming more reasonable (currently 13% EPS growth from about 20% a month ago) and a shift to a pro-growth policy stance may help to cushion earnings risks.
5. Best regional equity argument. We believe China appears best placed of all the regional markets to have a bear market rally, or potentially shift to a bull phase: its price fell most, its valuation has compressed in absolute and relative terms, and it has the most policy flexibility from a cyclical timing and fiscal position perspective.
 source: Goldman Sachs report
6. We estimate reward/risk at about 2.5 to 1. Based on current conditions, we estimate H share index upside at about 10,000 and downside risk around 7,200.
Against the current index level of roughly 8,000, this implies a 2.5 to 1 reward/risk ratio. We refresh our top-10 core holding list, highlight a basket of stocks with good rebound potential, and recommend a call spread collar or 1X2 call spreads.
Goldman Sachs said if global credit markets stabilize, China should outperform the region due to thecombination of valuation compression (below the regional average), better earnings outlook (even after downwards revisions), and the positive influence of the policy measures at the government’s disposal.
If global credit markets remain on edge, the Chinese equity markets should outperform due to a number of distinct advantages, including some of the world's best capitalized banks (which should keep the credit concerns at a distance), large current account and comfortable fiscal surpluses, a non-freely convertible currency (preventing an exodus of foreign capital), and for the A shares, hardly any redemption risk from foreign asset managers.
In addition to these natural advantages, Goldman Sachs feels the authorities are on sufficiently high alert, and have the heavy fiscal firepower at their disposal to better counteract a global contraction of growth and/or credit, certainly more than any other Asian country.
”Therefore we feel comfortable recommending a relative overweight on China, but retain some reservations about advocating an explicitly absolute overweight call.”
Related story: CIMB-GK'S top picks for a volatile market
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