Excerpted from Goldman Sachs Group's May Investing in China report
We believe Chinese equities are undervalued because the market has factored in too many risks in the valuations. The current implied risk premium of 9.2% is the highest among the regional markets and also 170 basis points (bp) higher than the historical average. Our top-down scenario analysis shows that if risk levels revert to normal, Chinese equities could rise as much as 21% by year-end. We reiterate our positive case on Chinese equities and expect a potential total return of 10%-15% in 2005 given positive earnings revisions and a solid macro outlook.
We argue that upstream resources and basic materials are still the places to invest because of China's still-robust GDP growth, but we take a more cautious stance for financials and industrials as we believe margin squeeze concerns may dampen share price performance. We change to neutral from overweight stance on telecommunications as we expect Chinese telco share prices will remain range bound in the near team. We maintain a neutral stance on the utilities sector and expect a share price rebound after the sharp correction in the past year.
Consumer and consumption-related companies should benefit most from China's growth story? Average purchasing power has been on an upward trend during the last decade as average nominal wage growth has outpaced the Consumer Price Index (CPI) in every year. Average nominal wages have increased from Rmb4,500 to Rmb16,000 during the last decade, or at a CAGR of 14%. In addition, the average household?s burden for food and residence has declined since 1993, whereas annual disposable income per urban capita has moved in the opposite direction. We believe increasing purchasing power, coupled with higher disposable income, will likely spur demand in the consumer goods sector.