Still room for upside! Goldman Sachs: Upgrades Chinese stock market to "overweight", expecting a further increase of 15-20%

After the epic surge in the Chinese stock market, both domestic and foreign institutions still have a strong bullish sentiment.

On October 5th, Goldman Sachs raised its rating on the Chinese stock market to "overweight" in its latest report, expecting a further increase of 15-20%. Goldman Sachs raised the target price of MSCI China from 66 to 84, and the target price of the CSI 300 Index from 4000 to 4600.

In terms of sector allocation, Goldman Sachs upgraded insurance and other financial sectors to overweight, metals and mining to neutral, and downgraded telecommunications services to underweight.

Estimated Upside of 15-20%

Goldman Sachs believes that the Chinese stock market still has further upside potential, estimating an increase of 15-20%:

There is currently not enough information to assert that a structural bull market has begun, as macro challenges remain severe and the scale and contours of fiscal policy have not yet been announced. However, there are ample reasons to believe that the stock market will provide additional returns.

Goldman Sachs raised the target price of MSCI China from 66 to 84 and the target price of the CSI 300 Index from 4000 to 4600, based on forward valuations of 12.0 times and 14.2 times (previously 10.5 times and 12.8 times). This implies a total return potential of approximately 15-18% from current levels.

Goldman Sachs arrived at the above conclusion by considering valuation, earnings, positions, and other factors:

Firstly, after recovering from the extremely low valuation of 8.4 times, it still remains below the median forward earnings of 11.3 times, lower by 0.4 standard deviations from the 5-year average of 12.1 times. If economic support policies continue to follow through, there is further potential for valuation recovery. Historically, Goldman Sachs has noted a good correlation between fiscal easing and valuation expansion.

Secondly, the market rebound can be seen as pricing out tail risks. Goldman Sachs' Dividend Discount Model (DDM) shows that the implied cost of equity (ICOE) has recently been at a high level, indicating market concerns about downside growth risks. A strong set of policy measures has reduced this risk, which should lead to a decrease in ICOE. This supports the expectation of further valuation recovery.

Thirdly, if the economy responds to policies, earnings growth may improve from the currently conservative forecasts. Improvements in earnings also tend to support valuation expansion.

Lastly, positions are light, and the outlook for the Chinese stock market points to further risk-taking. Hedge funds have rapidly increased their investments in China but are still at the 55th percentile of their 5-year range. For reference, at the peak of the rebound in January 2023, they reached the 91st percentile. As of the end of August, mutual funds were underweight China by 310 basis points, and sharp market movements will increase this underweight ratio. Onshore investors have also begun to increase margin financing at low levels, echoing the rise in risk appetite during the 2015 policy support period.

Taking a broader view, the Japanese stock market has experienced 7 rebounds of 50-140% during its nearly 30-year bear market, indicating that attractive investment opportunities can coexist with challenging macro backgrounds.

Goldman Sachs Upgrades Insurance and Other Financials to Overweight

Goldman Sachs will increase its allocation to China to overweight and states that the adjustment is tactical:

The increase reflects the potential for further returns driven by policy and the reflexive impact of sentiment and confidence, but more evidence of sustained implementation and progress in addressing macro challenges is needed to take a more confident long-term stance.

In terms of sector allocation, Goldman Sachs will increase insurance and other financials to overweight, metals and mining to market weight, and downgrade telecommunications services to underweight:

Given increased capital market activity and improved asset performance, insurance and other financials (such as securities firms, exchanges, investment companies) will be increased to overweight.

Additionally, by increasing metals and mining to market weight, cyclicality exposure is increased, driven by measures in the Chinese real estate market and potential fiscal stimulus, as well as a hedge against geopolitical risks.

On the contrary, due to their defensive nature, rising valuations, and lower sensitivity to interest rates, we will downgrade telecommunications services to underweight.

Goldman Sachs maintains its overweight position on internet and entertainment, technology hardware and semiconductors, consumer retail and services, and daily necessities. Goldman Sachs believes that these industries are expected to benefit from loose policies, provide structural growth opportunities (such as artificial intelligence and unique Chinese consumption trends), and are more sensitive to lower interest rates, with valuations ranging from reasonable to attractive