Chinese stocks are factoring in both accelerating inflation and declining growth, a "mispricing" that is poised to "correct soon", Morgan Stanley said.
The brokerage upgraded steel and building materials shares in its China portfolio to "overweight" from "underweight," a week after increasing the weighting of banks, analysts led by Jerry Lou wrote in a report. They maintained their end-2010 estimates of 81.7 for the MSCI China Index and 15,399 for the Hang Seng China Enterprises Index, representing gains of 40 percent and 37 percent, respectively, from yesterday's close.
Chinese stocks have tumbled this year as the People's Bank of China, the central bank, raised bank reserve requirements three times and policy makers introduced curbs on the property market to cool lending and curb speculation. The MSCI China has lost 13 percent in 2010, while the Hang Seng China Enterprises has dropped 15 percent. The Shanghai Composite Index, tracking the larger of China's two exchanges, is the only major Asian gauge that has retreated further, down 19 percent for the year.
"Growth will remain intact and inflation will peak in" the second half of 2010, the analysts wrote. "The market is likely to re-rate from the current cheap valuations."
Valuations for the MSCI China have slumped to 14.6 times reported earnings from last year's high of 22.6 times on Dec 4, according to data compiled by Bloomberg. The Hang Seng China Enterprises has a multiple of 13.4 times, compared with 21.5 times on Dec 4.
The Hang Seng China Enterprises fell 2.9 percent to 10,912.92 as of 11:53 am in Hong Kong. The gauge entered a so- called bear market after having retreated 21 percent from last year's high. The MSCI China also dropped 2.9 percent.
Building materials, steel stocks
China National Building Material Co, China Shanshui Cement Group Ltd, Maanshan Iron & Steel Co and Angang Steel Co were added to Morgan Stanley's China model portfolio, according to the report. They reduced holdings in consumer, automobile and media shares.
The analysts on May 17 added Bank of China Ltd, Bank of Communications Co and China Construction Bank Corp to the model portfolio, saying that the government may hold off on further tightening amid "uncertainties" in the global economic outlook.
An "unofficial pause" in the government's tightening efforts will be one of three possible catalysts for stocks gaining in the second half, Morgan Stanley wrote in yesterday's report.
