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Will China's RRR Cut End Bear Market for Stocks?

Chinese stocks, which have been languishing in recent months, got a shot in the arm on Thursday after the central bank cut reserve requirement ratios (RRR) for all lenders by 50 basis points.

An investor watches the electronic board at the stock exchange in Shanghai, China.
Chinafotopress|Getty Images
An investor watches the electronic board at the stock exchange in Shanghai, China.

Hong Kong’s benchmark Hang Seng rose 5.8 percent while the Shanghai Composite added 3.5 percent, despite weak manufacturing data that showed the factory sector shrank in November for the first time in nearly 3 years.

Analysts say to determine if the rally will continue for China’s markets will depend on whether the central bank action is a one-off measure, or the start of a shift in policy after three years of monetary tightening.

Barclays, which says the latest action will add about $62 billion of liquidity to the banking system, believes the RRR cut is the start of an easing cycle, and predicts three more cuts in bank reserves by mid-2012, as well as an interest rate cut sometime next year.

While the head of China Equity Research for HSBC Steven Sun also expects the beginning of an across-the-board change in monetary policy, he added that the impact on stocks for the long term remains unclear. "For the market to rally sustainably, we still need to see more conviction on growth outlook as well as financial sector reform," he said.

Sun noted that the problem in China wasn't the lack of liquidity, rather it was over-investment in areas such as property and the need to ensure that liquidity was reaching the right places, which, he highlighted, would require financial sector reforms.

Ironically, such reforms could lead to a rise in interest rates, some analysts point out. China has relied for too long on raising reserve ratios and imposing lending quotas to control credit. A more market-based system for credit would likely require a rise in interest rates, as the current 6.56 percent level is widely regarded as too low.

Eddie Tam, Chief Investment Officer at the Hong Kong-based hedge fund Central Asset Investments, said the more likely scenario for 2012 would be for the central bank to hike, rather than cut, rates.

He remains cautious about turning more bullish. "One data point doesn't make the trend," he said.

Betting on Asian Domestic Growth Stocks

Erwin Sanft, Deputy Head of Asian Equities Research at BNP Paribas, said he expects 2012 to be a good year for stocks in China as well as across the region.

"We're looking into next year at valuations which (are) at the bottom of their trading range," he said. “We've obviously seen a turnaround in policy in China to an easing stance, and it's an end to the policy tightening in India."

Sanft recommends that investors bet on domestic growth stocks in Asia. In a note to clients earlier this week, Sanft identified two dozen large-cap names in Asia that would do well even if growth in the developed world remains in the doldrums.

His top picks in China include coal producer China Shenhua and insurance company Ping An. He is also bullish on Samsung Electronics, Hyundai Motors, Singapore Telecom and Yahoo Japan.

Sanft said the basket of stocks the firm had identified was trading at just above 10 times earnings, but he admitted that with investors worried about growth, it was tough convincing people to buy.