China Corporate Earnings Growth

Capstone Research expects the government to step up with growth stabilization policies. We expect the government will resort to targeted stimulus and reforms to support consumer spending and ensure ample liquidity to rejuvenate private investment. Details of policies support is expected to be announced around the Two Sessions in March.

We continue to prefer three investment themes:

1) beneficiaries of growth stabilization policies, such as infrastructure, consumer staples and communication service sectors;

2) quality domestic plays with visible growth outlook that are insulated from further escalation of trade disputes;

3) defensive plays with yield support and low volatility, such as banks and selective energy plays.

A-share internationalization could be another investment theme to focus on, if MSCI consultation in raising weight of A-shares is approved.

Improving market sentiment; focus on corporate earnings growth

The Chinese equity market has rebounded as market sentiment has improved on the back of ongoing US-China trade negotiations and expectations of more growth stabilization policies to be rolled out. Overall, MSCI China is trading at 10.5x forward PE, rebounding from its low in early January of around 9x and has pricing in some positive signals.

We continue to prefer infrastructure, consumer staples and communications services that are expected to benefit from growth stabilization policies and the government’s commitment in promoting 5G network and its application and the resumption of gaming approvals.

For defensive plays with dividend yield support, we prefer selective energy stock and Chinese banks. Chinese banks as a sector which offers relatively high earnings visibility in the near term and around 5.9% dividend yield. Multiple RRR cuts is one of the major monetary easing that is expected by the market this year. For every 100bps RRR cut, Chinese banks’ net interest margin could be lifted by 1-3bps, and potential earnings enhancement. We also prefer selective HK banks with dividend yield support and the sector offers 5.5% dividend yield.

MSCI consultation of uplifting A-shares inclusion factor: a potential structural positive catalyst

MSCI will announce the results of its consultation on increasing the weight of A-shares in MSCI indexes by end of February. It proposes 1) to further increase the inclusion factor of A-shares in large caps from the current 5% to 20% in two phases in May and August 2019, 2) to add ChiNext to the list of eligible stock exchange segments in May 2019, and 3) to add China A mid-caps with a 20% inclusion factor in May 2020. If the consultation result is positive and is approved, China A shares’ weight in MSCI Emerging Market Index will be lifted from the current 0.7% to 2.8% in August 2019 and will further be raised to 3.4% in May 2020. It is estimated to bring around RMB250bn (or around USD37bn) of inflow to the A-share market from passively managed funds, as a result of uplifting inclusion factor from 5% to 20%

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