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More pain seen for China stocks before recovery

SHANGHAI (Reuters) - China’s stock market, the worst performer of the world’s major markets last year, faces more bad news from grim corporate earnings in the coming months, but signs are pointing toward a recovery starting in the second quarter.

A man reads information on an electronic screen in front of a board displaying the Shanghai Composite Index at a brokerage house in Shanghai January 22, 2009. REUTERS/Aly Song

By late April, the bad earnings news will be out of the way, liquidity in the markets will be rising and nascent expectations of a bottoming in economic growth rates will, analysts say, be on firmer ground.

But those hoping for an explosive rally may be disappointed as investors lick their wounds after big losses and a heavy supply of new equity absorbs much of the flow of new funds reaching the market.

“The common belief now is that China’s economy will bottom out in the second quarter as the government takes more steps to ensure 8 percent growth, pumping liquidity into the system,” said Wu Xiong, research manager at Orient Securities in Shanghai.

“So the stock market is also likely to begin a real rebound early in the quarter, but a bull run won’t be in sight this year as confidence will need time to recover.”

Among eight analysts, economists and fund managers polled by Reuters over the past week, six believe China's benchmark Shanghai Composite Index .SSEC could fall to around 1,500 points in late March or April -- the peak of the 2008 corporate earnings reporting season.

The index has climbed back to the 2,000 mark since the start of 2009 after ending last year at 1,820.8 points, a loss of 65 percent during 2008.

The six also forecast the index would recover around late April, reaching a peak around 2,500 points late in 2009, with further gains depending on the extent of recovery in the Chinese and global economies. The other two forecast a wider range of 1,300 to 3,000 for the year.

AWASH WITH LIQUIDITY

Rising liquidity could be a key source of steady upward momentum for the market as the year progresses.

The Chinese central bank is now pumping hundreds of billions of yuan into the banking system every month, in large part by virtually halting its bill issuance in its open market operations and letting redemptions of maturing bills automatically inject funds into the market.

The central bank has set a target for the broad M2 money supply to rise 17 percent in 2009, with economists estimating that will yield new bank lending of 4.8 trillion yuan ($702 billion) this year, up one-third from 2008.

Significantly, the target is 3 to 4 percentage points above the sum of the estimated growth rates for gross domestic product and inflation for 2009, exceeding those rates for the first time in several years.

This means that about 20 percent of the new loans would not be invested in the real economy but used to boost asset prices, economists estimate.

The market will also likely draw strength from rising confidence about a bottoming out in the economic growth rate, which slowed to 6.8 percent last quarter, the lowest in at least nine years.

“The market reached its most pessimistic forecast of the economy late last year,” said Ren Chengde, senior stock analyst at Galaxy Securities.

“It is now more actively factoring in government support steps, expecting investment to recover significantly in March, rising to the peak of recent years in June and helping China’s economic growth improve month-by-month starting in April.”

FRESH SUPPLIES OF EQUITY

However, the freeing of large volumes of state- and institution-owned shares for trading, as lock-up periods under state shareholding reforms expire, will add fresh supplies of equity, capping market gains, analysts said.

Plans to launch a new Nasdaq-style second board for small and start-up firms in Shenzhen this year will also absorb funds.

In addition, the market will have to endure a difficult earnings reporting season that will last until the end of April, the deadline for full-year 2008 and first-quarter 2009 results.

The season could yield some nasty surprises, but stocks are now significantly cheaper than a year ago.

The average price/earnings (PE) ratio of Chinese listed companies is now at around 16 times forward earnings, not a bargain by international standards, but down from a record high of 70 times in late 2007.

China’s 1,600 listed companies are set to post a year-on-year fall of around 10 percent in their combined earnings for the fourth quarter of 2008, their worst performance since a near-20 percent dive in the second quarter of 2006, analysts estimate.

“Most companies are likely to show an even worse performance in the first quarter of 2009,” said Zheng Weigang, head of the research at Shanghai Securities.

“But corporate earnings for the rest of the year are very likely to improve gradually, buoyed by various government economic incentives. Expectations in this regard could be reflected in the stock market early in the second quarter.”

Still, analysts’ estimates for a roughly 10 percent fall in corporate earnings in 2009 contrast sharply with surges of 43 percent in 2007 and 67 percent in 2006, which fueled a two-year bull run in stocks that boosted the benchmark index five-fold.

Analysts advise overweighting infrastructure stocks, such as railways and expressways, due to the government’s economic stimulus policies. Refineries’ earnings prospects will be boosted by lower crude prices and government fuel price reforms.

They warn that weakening demand would particularly hit auto, airlines and commodity stocks such as non-ferrous metals.

($1 = 6.84 yuan)

Editing by Edmund Klamann and Lincoln Feast

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