China market to remain range bound for now, says UBS

China's equities will continue to rise throughout 2009, says UBS, but with global economic demand and China's external demand remaining weak, momentum risks running ahead of fundamentals, which will lead to stretched valuations. UBS believes that this will be the biggest challenge facing investors in China in 2009 as index prices become more sensitive to negative news.

UBS notes that important seeds for the next bull run have been planted and strong liquidity and improving fundamentals will drive China to another multi-year high.

"While investors will continue to face challenges for the remainder of 2009, important seeds have been planted that will support a return to a bull market," says John Tang, China strategist at UBS. "The low interest rate environment in the medium term will continue to make equity investments more attractive and the pipeline of new government projects will ensure construction demand remains healthy for the foreseeable future."

The three prerequisites for the next bull market according to UBS are: recovery of external demand, substantial growth in large-item sales and an easing of over-capacity concerns.

"However there are still serious structural risks in the global economy with China facing the possibility of a slower pick-up in private investment and its external demand remaining fragile," Tsang says. "With this in mind, investors need to be aware of the risk of a significant index retreat as valuations become stretched. Therefore UBS does not advise investors to fully load their portfolios or stick to a buy and hold strategy for now."

UBS sets year end targets of 60 for the MSCI China Index and 12,000 for the Hang Seng China Enterprises Index (HSCEI or H-Share Index) implying an upside of 11% and 13% respectively.

"Beyond 2009, UBS expects more upside risks as the global economic problems pass," says Tsang. "And while we overweight financials, domestic consumption, energy and construction related sectors investors need to manage a range-bound period before positioning for the next big bull market."