Kinger Lau, the bank’s China strategist in Hong Kong, predicts the large-cap CSI 300 Index will rally 27 percent from Tuesday’s close over the next 12 months as government support measures boost investor confidence and monetary easing spurs economic growth. Leveraged positions aren’t big enough to trigger a market collapse, Lau says, and valuations have room to climb.

Goldman Sachs is sticking with its optimistic forecast in the face of record foreign outflows, the biggest-ever selloff by Chinese margin traders and a chorus of bubble warnings from international peers. The call hinges on the success of unprecedented government efforts to revive confidence among individual investors who watched equity values tumble by $3.2 trillion over the past three weeks.

And:

Lau says the government has enough firepower. Policy makers have already suspended initial public offerings, relaxed margin trading rules, cut transaction fees and directed state-run institutions to maintain or boost equity holdings. A group of 21 brokerages pooled at least 120 billion yuan ($19.3 billion) for a market support fund.

The central bank will probably keep easing monetary policy, Lau says, after four interest-rate cuts since November and reductions to banks’ reserve requirements. The outlook for China’s economic growth has improved for three straight months, according to the China Bloomberg Monthly GDP Estimate index.

While Lau concedes there are pockets of over-valuation in China, particularly in small-cap stocks, he’s less concerned about the broader market. The CSI 300, which has a heavy weighting in low-priced financial stocks, trades at 17 times earnings, versus more than 40 times in 2007.

David Fuller's view

Rapidly developing markets are prone to bubbles.  China’s Shanghai A-Shares (current p/e 17.84 & yield 1.89%), according to Bloomberg, and especially the smaller, considerably more speculative Shenzhen Composite Index (p/e 46.44 & yield 0.60%) certainly had bubble characteristics.  So did the China CSI 300 (p/e 15.82 & yield 1.72%) mentioned by Kinger Lau in the article above.  These are now mostly unwound, at least by the two larger indices.  

However, Hong Kong’s Hang Seng Index (p/e 9.77 & yield 3.49%) and China Enterprises (H-Shares) (p/e 8.12 & yield 3.68%) were not expensive at their April-May highs and are very reasonably valued today.  Yes, China’s slowing economy may push these valuations somewhat higher, but I would be wary of bearish forecasts which always increase as markets approach capitulation lows.  Additionally, I would be far more concerned if China’s government was not taking numerous steps to put a floor under its stock markets.

(See also Eoin’s comments on China below.)