China’s Top Stock Picker Sees 15% Rally on Graft Crackdown

Aug 06, 2014 3:12 am ET

(Updates index levels in eighth paragraph.)

Aug. 6 (Bloomberg) -- China’s anti-graft drive has gotten Cheah Cheng Hye more bullish on mainland stocks than at any time since valuations plunged in the global financial crisis six years ago.

The chairman of Hong Kong-based Value Partners Group, which runs the best-performing Greater China equity fund during the past five years, is predicting a further gain of about 15 percent for the Shanghai Composite Index by year-end. While President Xi Jinping’s anti-corruption measures may be a short- term drag on growth, they will make state-owned enterprises more efficient and help curb excessive debt, he said.

The call by Cheah, who was dubbed the Warren Buffett of Asia by Apollo Global Management’s Tan Chin Hwee for his long- term track record of picking undervalued stocks, pits him against Tom DeMark, the developer of market-timing indicators who forecast Aug. 4 that the rally may end within days.

“We are seeing that the anti-corruption campaign is for real,” Cheah, 60, whose $547 million Value Partners China Greenchip Fund returned an annualized 13 percent during the past five years to beat 134 peers tracked by Bloomberg, said in an Aug. 2 interview in Shanghai. “This is giving a lot of encouragement to investors.”

Xi’s campaign to rein in graft reached new heights last week as the government announced a probe of former security chief Zhou Yongkang, the highest-level corruption investigation since the ruling Communist Party came to power more than 60 years ago.

Useless Growth

The anti-corruption measures will improve the quality of China’s economic growth and bolster investor confidence, Cheah said. Gross domestic product will expand 7.4 percent this year, according to the median of 54 economist forecasts compiled by Bloomberg, compared with 7.7 percent in 2013 and 10.4 percent in 2010.

“The kind of growth you get from corruption is what we call useless growth,” said Cheah, whose firm manages about $10.5 billion. “Investors are willing to accept a lower growth rate in China. Maybe 6.5 percent growth is OK.”

China also needs to improve corporate governance if it wants to lure back investors after a 60 percent slump for the Shanghai Composite since the start of 2008, Cheah said.

The Shanghai gauge fell 0.1 percent to 2,217.47 at today’s close. It has gained 4.8 percent this year after rebounding 11 percent from its January low. The Hang Seng China Enterprises Index of mainland companies listed in Hong Kong entered a bull market on July 28 with a 20 percent rally from its March low, and has climbed 1.3 percent this year. The iShares China Large- Cap ETF sank 1.5 percent to $40.47 yesterday.

Relative Value

The Shanghai index trades at 8.2 times projected 12-month earnings, compared with the five-year average of 11.3, and the current multiple of 11 times for the MSCI Emerging Markets Index, according to data compiled by Bloomberg.

“I am quite optimistic,” Cheah said. “The market has bottomed out. We’re beginning to see the beginning of a recovery in the months of June and July. The strong performance may only be the beginning.”

Restoring trust in the equities market is crucial before the planned start of a link between the Hong Kong and Shanghai stock exchanges that will make it easier for international investors to buy mainland shares, Cheah said. The Hong Kong- Shanghai Connect is “very important” because it will narrow the valuation differential between dual-listed equities and its success would presage the possible inclusion of China’s local- listed A shares in global indexes, he said.

DeMark Call

Cheah is joining bulls from Templeton Emerging Markets Group to JPMorgan Chase & Co. Chinese stocks will rise an additional 20 percent, Mark Mobius, whose $13 billion Templeton Asian Growth Fund has outperformed more than 90 percent of peers this year, said July 24. Adrian Mowat, the chief emerging-market strategist at JPMorgan, last week raised his rating on Chinese stocks to neutral from underweight, predicting gains through October.

DeMark, who predicted the Shanghai Composite’s peak last year, says its current rally is poised to end. The gauge will probably fall below this year’s intraday low of 1,974.38 in about six months, he wrote in e-mailed responses to questions from Bloomberg News on Aug. 4.

Cheah, who co-founded Hong Kong-listed Value Partners in 1993 after a period as a financial journalist, favors shares of energy companies that will benefit from deregulation as well as those that will gain from a rebalancing of the economy toward health care, environmental protection and services.

Paramount Leader

PetroChina Co., which has rallied 19 percent in Hong Kong this year, and Shenzhen-listed Chongqing Changan Automobile Co., up 21 percent, were the two biggest holdings at the end of June in the firm’s $1.24 billion Value Partners Classic Fund, which has gained 18 percent during the past 12 months.

Since taking office 18 months ago, Xi’s anti-corruption campaign has ensnared more than 480 officials spanning all of China’s provinces and largest cities. The probe has toppled figures including Zhou, the former Politburo Standing Committee member and ally of ousted Chongqing party boss Bo Xilai. The probe into Zhou, a former head of PetroChina’s parent, “will unlock significant shareholder value” in the nation’s biggest oil company, Jefferies Group LLC said in a note last week.

“Fifty years from now, Xi Jinping will be seen in history in the same way as Deng Xiaoping, with the things he is doing now to boost confidence in the country,” Cheah said, referring to the former leader who opened up China’s economy in the 1970s.