China Stocks Broaden Appeal with Lower Valuations

After a third quarter that saw China's stocks fall, equities in the world's third-largest economy may now be too cheap to pass up.

The Shanghai Composite Index (SSE) was the worst performer among the so-called BRIC nations (Brazil, Russia, India, and China) in the third quarter, falling 6% as Chinese banks pulled the reins on lending. Meanwhile, benchmark stock indices in the other BRIC nations each gained at least 18% in the same period, marking the first time since late 2007 they rose as Chinese shares fell.

Following an eight-day holiday, the SSE started the fourth quarter today (Friday) with a 4.76% gain, the third-biggest gain for the index this year. Two of the three other BRIC indices continued their third-quarter momentum, as well. So far this quarter through yesterday, Brazil's Bovespa stock index is up 3.6%, Russia's Micex gained 6.8% and India's Sensitive Index, or Sensex dipped 1.7%.

"They are the best value equity play anywhere in the world," Robert Froehlich, senior managing director at The Hartford Financial Services Group Inc. (NYSE: HIG) told Bloomberg News. "Valuations and the Chinese consumer are a one-two punch."

Despite the SSE's third quarter slump, China stocks are still more expensive than those of the other BRICs. China's multiple of 30.85 compared with 22.1 for Brazil's Bovespa index, 20.8 for India's Sensex and 13.7 for Russia's Micex. Shares in the Hang Seng Index, which track Hong Kong-listed Chinese stocks, traded at a ratio of 20.8.

That isn't stopping investors from taking advantage of the relative lows. The valuation for the China stocks relative to Brazil's fell last month to the lowest level since May, Bloomberg data showed. The SSE also traded at its smallest premium over the Sensex in about 10 months prior to today and over the Micex in a year.

"China is where we are putting most of our money out of the BRICs," Peter Schiff, president and chief global strategist of Euro Pacific Capital Inc. and occasional guest columnist for Money Morning told Bloomberg. "Valuations are certainly better there. That is where the growth and profits are going to be."

Schiff recommends "domestic-demand plays" such as Dah Chong Hong Holdings Ltd., which owns car dealerships and food and consumer products outlets, and Xtep International Holdings Ltd., a sporting goods retailer. Both companies trade in Hong Kong.

Shares on the Hang Seng Index have gained 5% since the quarter began. The Bank of New York Mellon China ADR Index, which tracks American depositary receipts for Chinese companies, rose 3.5%.

Stimulus to Keep Going

While the pullback in lending from Chinese banks was largely blamed for the SSE's third quarter downturn, it does appear to be stabilizing.

Banks issued between 300 billion and 400 billion yuan in loans last month, roughly matching the lending in July and August, China Banking Regulatory Commission (CBRC) Chairman Liu Mingkang said earlier this week.

That doesn't mean Beijing is ready to start withdrawing from the $585 billion (4 trillion yuan) stimulus policy it implemented to prop up the Red Dragon's economy amid the worst recession in more than 60 years.

"It is too early to talk about an exit strategy for markets," Liu told a lunch in Hong Kong today, adding that Beijing's strategy was far different from those in the United States or Europe "because we haven't spent a penny to rescue the banks."

Liu's take on an exit strategy was a reiteration of what Finance Minister Xie Xuren said while attending the annual meeting of the International Monetary Fund (IMF) in Istanbul on Tuesday.

"China will continue its proactive fiscal policy and moderately loose monetary policy and will maintain its fiscal stimulus as we have still not seen a stable economic recovery," Xie said.

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