China's Capital Markets and Investment Strategy Dr. HUANG Haizhou With input from macro and strategy teams SFC CE Ref: AMU474 SAC License No. S0080511110002 December 24, 2014
Review: 2014 Global Investment Outlook Europe: Out of crisis but hardly grow Drag global growth and increase volatilities US: Cross the cliff and ready to recover Push up global growth EM: Economic reform and regain growth Investment opportunities and reform dividend Don t underestimate the impacts of China's accelerating reform Don t underestimate the dynamism of US steady recovery Don t underestimate the drag by Europe & Japan fluctuating slowdown 1
Review: China GDP growth declines in 2014 GDP QoQ GDP YoY % 10 CICC Macro 9 8.1 7.6 7.4 7.8 7.7 7.5 7.8 7.4 7.8 8.0 7.5 7.3 8 7 6 6.7 6.9 7.8 9.4 6.7 6.3 8.9 8.0 7.7 7.5 7.0 7.0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 5 2012: 7.7% 2013E: 7.6% 2014E: 7.6% Source: CEIC, CICC Research 2
Review: A-share Strategy A-share market likely to deliver 20% annual return in 2014. Macro: 2014 will be different from previous years as: Investors have downgraded expectations for the Chinese economy; A new round of reforms is likely to improve economic potential, balance and quality; and Earnings: we expect A-share earnings to grow 15.2% 2014 ( top-down); Valuation & Liquidity: CSI300 valuation at historical low in terms of PE/PB, Small-mid caps valuation at historical high; growth recovery has supported some moderate valuation expansion in large cap index. Real reforms will arouse revaluation of China. Sectors: We suggested buying three types of sectors towards the end of 2013: 1) Real estate, building materials and steel; 2) Mass consumer goods such as home appliances, foods and beverages; 3) Securities firms and insurance companies; Investors should also keep a close eye on the rail, shipping, airline, healthcare and media sectors. Meanwhile, we remain bearish on base materials (e.g. coal and non-ferrous metals) and sectors with stretched valuations and a gloomy outlook (e.g. electronic components). 3
2014 global markets: Facts In 2014, A-share market largely outperformed, Shanghai composite index jumped by 49%. H-share underperformed A-shares. The H- share market and Hong Kong HSI Index increased by 1%. US outperformed, NASDAQ +14%, S&P500+12%. Some EM, such as India (+30%), Indonesia (+20%), and Thailand (+18%) also rallied. EU markets lagged, Greece -26%, Portugal -20%, UK -3%, France -1%, Germany 2%. 2014 global markets review China A-share (SHCOMP) India (SENSEX) 30% Indonesia 20% Thailand 18% US (NASDAQ) 14% Ireland 14% US (S&P500) 12% Japan (NKY) 8% Taiwan (TWSE) 6% Singapore (FSSTI) 5% Spain 5% Germany (DAX) 2% EM (MXEM) 2% Australia (AS51) 2% China H-share (MXCN) 1% Europe (STOXX) 1% Hong Kong (HSI) 1% Italy 0% Russia (MICEX) 0% France (CAC 40) -1% UK (UKX) -3% Korea -3% Brazil (IBX) -4% China US ADR (HXC) -7% Portugal -20% Greece -26% Source: Bloomberg, CICC Research; data as of Dec 21, 2014 49% 4
Preview: GDP growth will recover modestly in 2015 China s GDP growth will be 7.3% in 2015. Slowing real estate investment will continue to drag down overall investment growth, but consumption will grow steadily, improving the structure of domestic demand. Policy easing and the ongoing reforms will help the economy recover to its potential growth rate. We expect GDP growth to rebound to 7.5% in 2016. CPI inflation is expected to be 1.4% or below in 2015. Inflation usually lags over the economic cycle, and will likely remain subdued amid weak domestic demand. We expect GDP QoQ growth to rise in 2H15 and CPI QoQ growth to rise in 2H15 GDP QoQ (NBS, SAAR) GDP YoY % 10 CPI QoQ (SAAR) CPI YoY % 3.5 7.7 7.5 7.8 7.7 7.4 7.5 7.3 7.4 7.5 7.3 7.2 7.3 9 8 7 2.4 2.4 2.8 2.9 2.3 2.2 2.0 1.5 1.5 1.4 1.3 1.5 3.0 2.5 2.0 1.5 1.0 6 0.5 6.6 7.4 9.5 7.0 6.1 8.2 7.8 7.5 6.6 7.2 7.5 7.8 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013: 7.7% 2014E: 7.4% 2015E: 7.3% 5 3.4 2.2 3.0 3.0 1.1 1.8 2.0 1.0 1.0 1.4 1.8 1.8 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013: 2.6% 2014E: 2.0% 2015E: 1.4% 0.0 Source: CEIC, CICC Research 5
The macroeconomic policies need to quickly adjust to the new normal The macroeconomic policies need to quickly adjust to the new normal, given the economy has entered a new normal growth phase of 7~7.5% as compared to the average ~10% in the past decade. Relative to the speed of economic slowdown, policy response has been slow. Targeted easing by the central bank lacks transparency and effectiveness in guiding expectations. Despite the government s repeated call for lowering financing costs, the real riskfree interest rate remains high, in stark contrast to other major economies. Current monetary policy is still tight Real interest rates are high Total social financing YoY % 40 Real interest rate of consumer % 15 35 30 Real interest rate of invester Real interest rate of home buyer 10 25 5 20 15 0 10-5 5 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0 2009 2010 2011 2012 2013 2014-10 Source: CEIC, CICC Research 6
Obstacles to broad policy easing are waning The reforms launched since the 3rd plenum of the 18th CPC Central Committee are improving resource allocation, thus reducing any potential side effects from monetary easing. The property market has cooled down, removing another constraint on policies. Falling inflation, especially falling oil and property prices, has granted room for significant monetary easing. We expect the PBOC to cut the and cut benchmark interest rates in 2015. Fiscal deficit is expected to expand slightly in 2015, lending support to economic growth as well. Falling oil price to be passed on to CPI Falling housing price weighs on rent growth % 100 Brent oil price YoY (LHS) CPI YoY (RHS) % 10 70 city housing price YoY CPI rent YoY % 16 80 8 14 60 40 6 12 10 20 4 8 0-20 -40-60 -80 2001 2003 2005 2007 2009 2011 2013 2 0-2 -4 2006 2007 2008 2009 2010 2011 2012 2013 2014 6 4 2 0-2 -4 Source: CEIC, CICC Research 7
Reform drives long-term economic cycle Implementation of reform/opening-up and household responsibility system China potential output (H-P Filter) Southern tour speech and proposed shift to a socialist market economy Join WTO % 12 11 10 9 1981 1986 1991 1996 2001 2006 2011 Source: CEIC, CICC Research 8 8
Stock market perform well in 2014, driven by lowering systemic risk/financing cost/oil and commodities prices 2014 YTD market performance SHCOMP Index vs. China's GDP Growth 3,500 3,300 3,100 2,900 2,700 2,500 2,300 2,100 1,900 1,700 YTD: 331 stocks return >100% 1707 stocks return >30% 2391 stocks return >0% 13.0 12.0 11.0 10.0 9.0 8.0 7.0 6.0 1,500 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 2008: -65.4% 2009: 80.0% 2010: -14.3% 2011: -21.7% 2012:3.17% 2013:-6.7% YTD:26.7% 5.0 SHCOMP Index (LHS) GDP: YoY Growth Source: Wind, CICC Research 9
We hold positive opinions on 2015 A/H markets Policy easing will reduce market interest rate and improve liquidity, which should encourage risk taking and mitigate tail risk in economic growth. Structural reforms should continue to improve China s growth quality and sustainability. Valuations of current A/H markets are at low levels. 10
A-share: 2015E top-down earnings should grow by 10.6% Earnings forecast: Top-down: 2012A 2013A 2014E 2015E 2016E Non-financials Revenue growth 7.9 9.1 5.0 7.7 9.0 Net margin 4.16 4.36 4.42 4.67 4.97 Earning growth -11.8 14.4 6.8 15.1 16.0 Financials 13.7 14.7 10.3 7.1 7.9 Overall 0.8 14.5 8.7 10.6 11.6 Source: Wind, CICC Research 11
H-share: 2015E top-down earnings should grow by 10.5% CICC Top-dow n Forecast vs. Consensus Sales Grow th Net Margin Net Income Grow th Net Income Consensus Revision from Now 2012A Non-finan. 10.7% 5.9% -9.5% Financials 14.5% H-shares 1.3% 2013A Non-finan. 11.1% 6.2% 14.2% Financials 17.6% H-shares 15.9% 2014E Non-finan. 6.0% 6.2% 5.7% 5% 1% Financials 9.0% 10% -1% H-shares 7.4% 7% -0% 2015E Non-finan. 8.0% 6.5% 13.3% 14% -1% Financials 7.9% 9% -1% H-shares 10.5% 11% -1% Source: Bloomberg, CICC Research 12
Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 A-share valuation: large-caps still at historical low, mid- and small-caps have seen correction 50 45 40 35 30 25 20 15 10 5 0 CSI 300 CSI 500 SME GEM Source: Wind, CICC Research 13
Dec-04 May-05 Oct-05 Mar-06 Aug-06 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 MSCI China valuation is at historical trough 12m fwd P/E (X) MSCI China MXCN ex. Financials MXCN ex. Financials & Energy 30 25 20 15 10 Average = 11.9x -1 std. dev. = 8.6x +1 std. dev. = 15.2x 13.0x 12.4x 9.0x 5 Source: Bloomberg, CICC Research 14
Jan/13 Feb/13 Mar/13 Apr/13 May/13 Jun/13 Jul/13 Aug/13 Sep/13 Oct/13 Nov/13 Dec/13 Jan/14 Feb/14 Mar/14 Apr/14 May/14 Jun/14 Jul/14 Aug/14 Sep/14 Oct/14 Nov/14 Liquidity to gradually ease Wealth management products yields have been falling Rmb has been appreciating recently (%) Wealth management products' expected yields (1 year) 6.30 6.0 CNY central parity rate CNY Spot 6.10 6.1 5.90 6.2 5.70 5.50 6.3 5.30 6.4 5.10 6.5 4.90 4.70 6.6 Appreciation against the US dollar 4.50 6.7 Jan/11 Jul/11 Jan/12 Jul/12 Jan/13 Jul/13 Jan/14 Jul/14 Source: Bloomberg, Wind, CICC Research 15
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Other factors that help to improve liquidity: China households asset allocation changes; A-share market gradually opens and attracts fund inflows China s asset value breakdown by asset class US asset value breakdown by asset class Deposit, 7.4% 250 200 150 100 50 0 Real Estate, 53.5% (RMB tn) Deposit, 20.6% Bond, 11.5% Insurance, 3.8% Stock, 10.6% 116.2 8.3 25.0 23.1 44.8 140 120 100 80 60 40 20 0 Insuranc e, 19.2% Real Estate, 19.4% (USD trn) Bond, 33.0% Stock, 21.0% 22.3 22.0 37.8 24.0 8.4 Deposit Stock Bond Insurance RealEstate Deposit Stock Bond Insurance RealEstate Source: Wind, Fact set, CICC Research 16
2015 China Outlook: Bull market for stocks and bonds; more for stocks We expect China s A/H market to gain ~20% in 2015 1.Policy easing will reduce the market interest rate and improve liquidity, which should encourage risk taking and mitigate tail risks in economic growth. The decline in the real interest rate will likely boost the CSI 300 s 12-month forward P/E from 7.6x to ~8x. 2.Structural reforms should continue to improve China s growth quality and sustainability. our top-down A-share growth forecast is 10.6% for 2015. Increase exposure to interest rate-sensitive sectors Our sector allocation ideas for 2015 are based on three key factors: Policy easing, continued structural reforms and global technological progress. Specifically, we suggest: 1.Increasing exposure to real estate, securities firms, insurance names and small/medium-sized banks. 2.Overweight consumer sectors with stable growth and inexpensive valuations, such as healthcare, food & beverage and internet & media; as well as pick stocks from other consumer sectors, such as retail, home appliances, auto & parts and tourism. 3.We are less optimistic on oil & gas, apparel & textiles, telecoms and tech hardware. Investment themes, market styles and model portfolio Investment themes: possible investment themes include: SOE reform and land system reform. Market style: We expect the market to favor blue chips over small-mid caps due to reforms and policy easing. 17
2015 H-share Outlook: A year of policy easing & structural reforms Return expectation: ~28% upside by end-2015 1.China is entering a policy easing cycle. A lower real interest rate should help reduce tail risks and encourage risk taking 2.Ongoing structural reforms might become much broader and more comprehensive, reinvigorating China s longer-term growth potential 3.Current subdued valuations mean H-shares are still an attractive sweet spot among global markets, with ample room for further re-rating Earnings to recover on better revenue growth and higher margins; falling EPR and rates to lift valuations After a likely soft patch in 2014 (+7.4% YoY), we expect H-share earnings growth to recover to 10.5% in 2015, boosted especially by non-financials (13.3% vs. 2014 s 5.7%), thanks to both better revenue growth and higher margins. Implementation: time to add cyclical exposures We believe it is time to gradually add exposure to cyclical sectors and quality consumer names with solid growth visibility and reasonable valuations. Specifically, we would overweight financials (real estate, banks, insurers and brokers) among the old plays, and internet and healthcare in the new space. We suggest underweighting telecom, retail, apparel, etc. In terms of thematic investment opportunities next year, we would watch SOE reforms, mass consumption amid further urbanization, population aging, and environmental protection, etc. 18
Fast Forward: Global economic growth contributors Emerging Asian economies to contribute close to 55% to global growth in next 10 years US and EU to contribute less than 20% Three economies with double digit growth contributions Contribution to World economic growth by region between 2013-2023 Source: IMF, BBVA 19
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