LONDON / SHANGHAI - China's biggest investment bank is turning "cautious" on the country's stocks, just as six of its overseas rivals and the manager of the largest mutual fund say it's time to buy.

China International Capital Corp (CICC) predicted slowing economic and earnings growth will limit equity gains after the Hang Seng China Enterprises Index rose 7.1 percent this year, the best advance among major Asian indices. The top-ranked provider of China research in Asiamoney's survey recommends "defensive" companies including drugmakers and consumer staples producers.

"We're turning cautious," Hao Hong, the global equity strategist at CICC, said in an April 13 interview in Shanghai. "Economic growth is going to slow down in the coming months."

CICC's reduced outlook follows recommendations to boost Chinese stock holdings in the past month from Goldman Sachs Group Inc, JPMorgan Chase & Co, Macquarie Group Ltd and HSBC Holdings Plc. Further gains of at least 14 percent have also been forecast by Credit Suisse Group AG and Deutsche Bank AG. Pacific Investment Management Co, which oversees $1.2 trillion, said this week it has a "large overweight" position in China.

While the country's shares have rallied for three straight weeks on speculation that the People's Bank of China is near the end of its campaign to tighten monetary policy, Hong said bullish investors may be disappointed.

Rate bets

The Hang Seng gauge of Chinese shares listed in Hong Kong, also known as H shares, dropped 23 percent in the six months after the central bank stopped raising rates in 2007, underperforming the MSCI Emerging Markets Index by 14 percentage points. In 2004, the H-share gauge rose about 3 percent after rate increases ended, trailing the MSCI index by 8 percentage points.

"Consensus sees the beginning of the end of the interest-rate hike cycle and thus is getting bullish," Hong said in a report sent to clients on April 10. "The end of the cycle is not necessarily bullish judging from the experiences of 2004 and 2007."

Hong, a former analyst at Morgan Stanley and strategist at Citigroup Inc, predicted in January 2010 that stocks would retreat as the government reined in property speculation. The Hang Seng China gauge dropped 10 percent in the first half while the Shanghai Composite Index of so-called A shares traded on the mainland declined 27 percent. The Shanghai gauge slipped 0.2 percent to 3,035.59 on Friday

In November 2010, Hong advised investors to refrain from buying Chinese stocks after the biggest rally in 15 months. The Hang Seng China gauge declined for four straight months.

Inflation jump

China's economy grew a more-than-estimated 9.7 percent in the first quarter and inflation accelerated in March to the fastest pace since 2008, the National Bureau of Statistics said on Friday.

Consumer prices rose 5.4 percent from a year earlier, the statistics bureau said. The median forecasts in Bloomberg News surveys of economists were for growth of 9.4 percent and inflation of 5.2 percent.

China has increased its benchmark lending rate by 1 percentage point to 6.31 percent since October and lifted banks' reserve requirements three times this year to fight inflation and curb real-estate speculation.

Policymakers will lift the key lending rate to 6.56 percent by the end of the year, according to the median forecast in a Bloomberg survey of 20 economists on March 22.

Credit Suisse, Switzerland's second-biggest bank, boosted its 12-month forecast for the Hang Seng index a day after the central bank's rate increase on April 5. HSBC, Europe's largest lender, increased its rating on China to "overweight", while Macquarie, Australia's biggest investment bank, said investors should lift holdings because the central bank is near the end of raising borrowing costs.

Chinese stocks were upgraded to "overweight" from "market weight" the previous week by analysts Helen Zhu and Timothy Moe at Goldman Sachs, the fifth-biggest US bank by assets. They recommended banking and property shares and kept their 12-month target of 16,500 for the Hang Seng index. Jun Ma, a Hong Kong-based strategist at Deutsche Bank, Germany's biggest lender, said in a report distributed on March 21 that Chinese shares may climb about 25 percent.

Cut cyclicals

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Frank Li, the China strategist at JPMorgan, said stocks may "seesaw" before a "sustainable rally" late in the third quarter.

"Growth will be stronger than market expectations," Deutsche Bank's Ma said in an interview on Thursday. "We're expecting a small re-rating of the market as the macro fears recede."

The MSCI China Index of mostly Hong Kong-listed China stocks "is cheap", Ma said. The gauge trades at 12 times estimated earnings, compared with its historical average of 14.8, according to data compiled by Bloomberg. The Hang Seng gauge is valued at 11.1 times, compared with 11.6 for the MSCI Emerging Markets Index.

CICC's Hong advised investors to cut holdings of companies that rely on accelerating economic growth to boost earnings, including raw-materials producers. Profits at China-listed companies will rise about 19 percent in 2011, down from 40 percent last year, according to CICC estimates.

Bloomberg News