China Stock Slump Restores Value, Merrill Lynch Says

(Bloomberg) -- China’s stock market slump has restored value, making it more attractive than Asian nations including South Korea and India, Bank of America Corp.’s Merrill Lynch unit said. China is as “oversold” relative to the region as a year ago, while South Korean and Indian valuations look “extended,” Merrill Lynch strategists Sadiq Currimbhoy and Jacky Tang wrote in a report yesterday. Asia excluding Japan shares will lag behind global equities in “coming weeks,” they added.

The MSCI China Index, which tracks Hong Kong-traded Chinese shares, has dropped 7.8 percent from the high on Aug. 3, trimming gains this year to 41 percent. The relative strength index of China relative to the rest of the region is less than 30, the level that signals to some analysts that prices are poised to rebound, according to data compiled by Merrill Lynch.“Whenever the RSI of relative MSCI China to the rest of Asia gets this weak, China typically outperforms the region,” the analysts wrote. “Based on our estimated sustainable return on equity, the market is no longer expensive, even on our more conservative estimates for margins and asset turnover.”

In China, the brokerage favors property shares including Sino-Ocean Land Holdings Ltd. and Intime Department Store Group Co., according to the report.China’s return on capital employed is at about 10 percent, 60 basis points lower than the Asian average, the brokerage said. A basis point is 0.01 percentage point. The market’s return on equity is about 15.5 percent, compared with the average of about 16.3 percent for the region, it added.

‘Bright Spot’
Merrill Lynch joins Goldman Sachs Group Inc. in being optimistic about the prospects for Chinese shares. China stocks remain a “bright spot” among global equities because of the nation’s growth potential, Goldman Sachs said on Aug. 31.Chinese shares traded in Shanghai and Hong Kong are among the worst performers globally in the past month on concern that a slowdown in lending growth may derail a recovery in the world’s third-largest economy.

Mark Mobius, executive chairman of Templeton Asset Management Ltd., on Sept. 2 recommended China’s shares because of fast growth in the country, the China Times reported on its Web site. Mobius said recent declines in the equities happened because valuations were high and a correction is a normal scenario, the Taipei-based Chinese-language daily reported.

Production Capacity
Authorities can’t be “blindly” optimistic as a “decline in external demand may continue for a longer time” and excess production capacity may restrain industrial growth, Premier Wen Jiabao was quoted as saying on the government’s official Web site Aug. 24.Asian stocks have declined less than China, with the MSCI Asia-Pacific excluding Japan Index down 1.7 percent from this year’s high. The region is trading at a 10 percent premium to global shares, even as estimated return on equity ratios are at similar levels, Merrill Lynch said. A build-up in South Korea’s inventory levels relative to exports indicates that equities will “do poorly,” it added.“Our cyclical models are at an extreme and historically, this marks a peak in Korea’s equity market performance,” the strategists said. “The market is also extended on valuation grounds. In India too, valuations look extended.”