After a epic surge in the Chinese stock market, both domestic and foreign institutions remain optimistic.

On October 5th, Goldman Sachs raised its rating on the Chinese stock market to 'overweight' in its latest report, expecting 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 industry allocation, Goldman Sachs upgraded insurance and other finance to overweight, metals and mining to neutral, and downgraded telecommunication services to underweight.

Estimated potential for another 15-20% increase.

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

It is not yet certain that a structural bull market has begun due to ongoing macro challenges and the scale and outline of fiscal policy have not yet been announced. However, there are ample reasons to believe that the stock market will generate 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, respectively (previously at 10.5 times and 12.8 times). This implies an increase of approximately 15-18% in total return potential from current levels.

Goldman Sachs concluded the above analysis based on factors such as comprehensive valuation, earnings, and positions.

First, after the valuation recovered from the extremely low level of 8.4 times, it still remains below the median forward earnings of 11.3 times, 0.4 standard deviations lower than the 5-year average of 12.1 times. If economic support policies continue to follow suit, there is further potential for valuation recovery. Empirically, Goldman Sachs notes a strong correlation between loose fiscal policy 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) for the stock market is currently at a high level, indicating market concerns about downside risks to growth. A series of strong policy measures have reduced these risks, which should lead to a reduction in ICOE. This supports the expectation of further valuation recovery.

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

Finally, with light positions and changing outlook for the Chinese stock market pointing to further risk-taking, hedge funds have rapidly increased their investments in China, but are still in 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' underweight on China was 310 basis points, and sharp market movements will increase this underweight. Onshore investors have also begun to increase margin financing at low levels, echoing the rise in risk appetite during policy support in 2015.

From a broader perspective, 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 has upgraded insurance and other finance to overweight.

Goldman Sachs has increased its allocation to China to overweight and stated that the increase is tactical.

The upward adjustment reflects the potential for further returns that may be brought about by policy-driven and its reflexive impact on sentiment and confidence, but more confident long-term positions can only be taken with continuous implementation evidence and progress in addressing macro challenges.

In terms of industry allocation, Goldman Sachs will increase insurance and other finance to overweight, metals and mining to equal weight, and downgrade telecommunication services to underweight:

Given the increase in capital market activities and improved asset performance, insurance and other finance (e.g., brokerages, exchanges, investment companies) have been upgraded to overweight.

Furthermore, by increasing metals and mining to market weight, it increases cyclical exposure, a move driven by measures in the Chinese real estate market and potential fiscal stimulus as a hedge against geopolitical risks.

On the contrary, due to its defensive nature, rising valuations, and lower sensitivity to interest rates, we have downgraded telecommunication services to underweight.

Goldman Sachs maintains an 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.

Editor/Somer