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China Equity Bulls Still Wait For Their Moment in the Sun

Low valuations, market reforms and the prospect of monetary easing were all supposed to bring about a long-awaited turnaround for China’s languishing stock market this year, but halfway into 2011 and Chinese stocks have failed to live up to their promise.

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Instead, the Shanghai Composite Index is on track to post a disappointing performance for the third year running, when compared to Hong Kong’s Hang Seng Index or the S&P 500 .

So far this year, the Shanghai Composite is up 1.5 percent compared to a gain of 4 percent for the Hang Seng Index and a 5 percent gain for the S&P 500 Index.

Stocks in Shanghai have been mired in a slump after declining 22 percent in 2011, when it was one of the worst performing markets in Asia, as a series of credit-tightening measures by the Chinese government hurt investor sentiment.

But analysts who’ve been predicting a major breakout for the market are still sticking to their views, pinning their hopes on a reversal of monetary tightening as well as financial-sector reforms to stimulate the economy.

Chris Tang of Marco Polo Pure Asset Management told CNBC her firm was sticking to its guns and forecasting a huge rally in the coming years.

“We will see a bull run over the next 24 months," Tang said. "This year there will be a rerating story…We will see the new government pump up the economy very fast, and what’s very encouraging is that capital account opening and financial reforms have been much faster than we expected.”

Marco Polo expects China's A shares to gain between 200 and 500 percent over the next few years, to hit between 7,500 and 12,500, a forecast the firm made in August last year. The firm’s views are at the most bullish end of the spectrum.

What’s going to turn things around, analysts believe, will be the China Securities Regulatory Commission’s decision in May to allow domestic brokerages, which now get most of their money from trading stocks and underwriting new securities, to expand into futures and derivatives, asset management, private banking and private equity.

China is also making plans to let Chinese insurers manage offshore yuan funds, a business now limited to fund houses and brokerages, giving a potential boost to the financial sector.

Like Tong, Cedric Ma, Convoy Asset Management’s Senior Investment Strategist in Hong Kong, is also betting on these reforms to boost Chinese equities in the second half of the year.

“I remain positive about Chinese stock as I think the latest interest rate cut decision, falling inflation, and talk from government officials on, e.g. refocusing on infrastructure projects have indicated the monetary policy is no longer restrictive,” he told CNBC.

Ma said even though second-quarter economic data, such as gross domestic product (GDP) will continue to get weaker and there will be no large economic stimulus, the Chinese economy should begin rebounding in the third quarter.

According to him, the Shanghai Composite could hit 2,373 this year, representing an upside of about 7 percent from current levels, bringing the year’s gains to about 10 percent.

On the other hand, Goldman Sachs, which forecast that Shanghai stocks would increase 30 percent this year, has adjusted its expectations for the market.

Helen Zhu, Chief China Strategist at the investment bank, said in a report this month that investors had already priced in the government’s expansionary measures and Shanghai stocks no longer looked that attractive when compared to stocks in Hong Kong.

“Consensus now expects more China loosening than before, post the recent rate cut and higher than expected (bank) lending in May,” she wrote.

Instead, from here on, the main driver of Chinese stocks will be external factors, she said.

- By CNBC's Jean Chua.

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