Chinese stocks’ US$1.8 trillion recovery from April low faces another earnings test as UBS, Citic predict setbacks

  • The 800 biggest companies on the Shanghai and Shenzhen exchanges could suffer a 23 per cent drop in second-quarter profit, according to Citic Securities
  • Expect market to consolidate in the next two months on mild economic recovery and earnings downgrades, UBS strategist says

The appetite for China stocks could be tested soon, after a rally that added US$1.8 trillion of market value over the past two months, as listed companies release their next set of corporate earnings.

Second-quarter results due over the coming weeks, might pose a headwind to yuan-denominated stocks in the CSI 300 Index, which has rebounded 17 per cent from a low in April. Measures taken by Beijing to spur growth are expected to take time to translate into stronger income statements and balance sheets, analysts said.

UBS Group forecast slower growth for companies on the CSI 300, saying earnings are likely to trail projections. A broader base of 800 top companies in Shanghai and Shenzhen might suffer a 23 per cent drop in second-quarter earnings, according to Citic Securities, China’s biggest publicly traded brokerage.

“We expect the market to consolidate in the next two months on a mild economic recovery and earnings downgrades,” said Meng Lei, a strategist at the Swiss bank in Shanghai. “In our base case, we expect a more material valuation re-rating from the late third quarter. Any market pullback would provide an attractive [buying] opportunity.”

The caution suggests the massive recovery in market value over the past two months – aided by the lifting of the Shanghai lockdown and increased macro-policy support – may have run ahead of fundamentals and valuations.

A breather before another ascent in the third quarter is likely, UBS said, allowing traders to digest earnings downgrades and other potential pitfalls. The Swiss investment bank expects earnings for CSI 300 stocks to climb 4 per cent for 2022, against market consensus of 15 per cent.

Meanwhile, the contrasting fortunes of commodity producers and manufacturers likely deepened in the second quarter, according to Citic Securities. Higher prices will fatten profits for raw material producers, while squeezing margins of manufacturers and consumer-goods makers, it added.

The brokerage expects the top 800 mainland companies to report a smaller earnings drop of 10 per cent in the third quarter, before charting a 24 per cent growth in the last quarter.

“The valuation repair will continue after the digestion of the second-quarter results,” said Zhu Zhiyong, an analyst at AJ Securities. “The valuations are not elevated and have further upside room. As the economy continues to recover, so will earnings and that will also further drive up valuations.”

More tailwinds could be expected later in the year. President Xi Jinping last week pledged to achieve the national target annual growth of 5.5 per cent, bolstering speculation Beijing will further ease policies to sustain an economic recovery.

“While high-frequency data points to an improvement in industry sentiment that will lead to rotational buying, the pace of sector rotation and re-evaluation will be tempered by the interim results,” said Qin Peijing, an analyst at Citic Securities.

Author: Zhang Shidong, SCMP

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