Morgan Stanley Sees ‘Boom and Bust’ for China Stocks (Update2)

By Shiyin Chen
Dec. 16 (Bloomberg) -- China stocks are headed for a "boom and bust" in 2010 because a rally in the first half may stall as inflation accelerates and the government withdraws some stimulus, Morgan Stanley said.
"We see a temporary window of high growth and low inflation in the first half of 2010 followed by rising inflation worries in the second half," Morgan Stanley analysts led by Jerry Lou wrote in a report dated yesterday. "This means an equity market boom and bust in the same year."
The MSCI China index may rise to 81.7 next year, higher than an earlier forecast of 74.1, the analysts said. They cut their forecast for the Hang Seng China Enterprises Index, a Hong Kong index of mainland stocks, by 5.3 percent to 15,399 to reflect the valuation of bank shares and raised their estimate for Hong Kong’s Hang Seng Index by 11 percent to 25,716.
Morgan Stanley’s forecasts translate into gains of as much as 25 percent for Chinese shares and an 18 percent gain in Hong Kong equities from yesterday’s close. The MSCI China, tracking mostly Chinese companies traded in Hong Kong, climbed 0.3 percent to 65.31 as of 10 a.m. in Hong Kong, while the Hang Seng Index added 0.3 percent to 21,885.88. The gauges have both climbed more than 50 percent this year.
Analyst expectations of strong growth in China appear to be "unanimous," with earnings-per-share for the MSCI China forecast to grow 21 percent, the Morgan Stanley analysts said.
This means that the cost of capital and the strength of the U.S.
dollar will be a bigger factor for Chinese equities next year.
China’s government will probably adopt a "moderate" exit to its monetary and fiscal policies in order to ensure that infrastructure projects will be completed, the report said. High domestic grain prices relative to international markets will provide an "inflation buffer," Morgan Stanley said.

Potential ‘Shocks’

Still, a strong recovery in developed economies and potential inflation "shocks" could send Chinese and Hong Kong shares lower more than 20 percent from yesterday’s level, Morgan Stanley said. The brokerage’s so-called bear-case scenario forecasts a drop to 50.4 for the MSCI China and a decline to
17,161 for the Hang Seng Index.
"Growth generally leads inflation by six months in the U.S., which means a growth shock in the U.S. might lead the inflation shock this time -- if there is one in 2010," the analysts said. "If the U.S. property market rebounds surprisingly, we would sell China equities because inflation could shock and the dollar strengthen."
Investors should own consumer, insurance, Internet and media, phone and energy shares in China next year and hold fewer banks, developers and materials suppliers because the risk of a policy exit, according to the brokerage.

Mainland Developers

China stocks will probably be in a "slowly rising bull market" next year, Royal Bank of Scotland Group Plc analyst Wendy Liu said today in a Bloomberg Television interview in Hong Kong. Still, so-called asset plays including banks and property may need to "calm down a bit" after this year’s rally, she added.
CLSA Asia-Pacific Markets is more bullish on Chinese property shares, saying that policy changes have been "factored into" prices and the government needs the industry to bolster consumer spending, according to Manop Sangiambut, the brokerage’s Shanghai-based head of China A-share research. He has an "overweight" rating on mainland-traded property stocks.
In Hong Kong, Morgan Stanley is also becoming more cautious on real-estate shares, saying that it prefers banks and consumer stocks. The brokerage is adding Giordano International Ltd., Standard Chartered Plc and two other stocks to its so-called focus list for Hong Kong and removing Great Eagle Holdings Ltd.
and Hysan Development Co.
"The Hong Kong property sector, a big beneficiary of the global low cost of capital and China’s liquidity overflow in 2009, will slow down first, while the banking and consumer sectors will continue to ride the China boom and global economic recovery," the analysts wrote.