China’s biggest stock-market rout since 1992 has done nothing to erode the bullish outlook of Goldman Sachs Group Inc.

Kinger Lau, the bank’s China strategist in Hong Kong, predicts the large-cap CSI 300 Index will rally 27 percent 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.

“It’s not in a bubble yet,” Lau said in an interview. “China’s government has a lot of tools to support the market.”

Lau, who set his CSI 300 target on July 1, confirmed on Tuesday that the projection still stands. He’s been forecasting gains in Chinese shares for much of the past year, a stance that paid off as the CSI 300 surged to a seven-year high last month.

Bubble Warnings

The past few weeks, however, have been painful for bulls. The CSI 300 is down 27 percent from its peak and the Shanghai Composite Index just completed its biggest three-week tumble in more than two decades.

Margin traders reduced positions by more than 7 percent on Monday as the unwinding of leveraged bets extended for an unprecedented 11th day. Selling through the Shanghai-Hong Kong exchange link over the past two days swelled to a record, while strategists from BlackRock Inc. to Credit Suisse Group AG and Bank of America Corp. all warned of unsustainable valuations at the end of last month.

Even after the median price-to-earnings ratio in China dropped to 55 from 108 at the height of the rally in June, valuations are more than twice as high as those on the Standard & Poor’s 500 Index.

“The Shanghai market is still expensive,” Mark McFarland, the chief global economist at Coutts & Co. in Hong Kong, said. Policy measures to support prices are “unlikely to be successful in the short term. Ultimately it’s people’s minds that you have to get into, to get confidence up. That’s a difficult task.”

State Buying

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.

“Re-rating is not over for China’s stock market,” Lau said. “We are still positive.”