China Corporate Earnings in Focus

Investment summary

With valuation of Chinese equities market becoming inexpensive, focus will shift toward earnings growth. Earnings momentum have heated up over the past couple of months, we think the current 2019 earnings growth estimate of 13.1% is realistic. We forecast the earnings upward pressure to further continue in 2019. As such, equities market is likely to gain upside momentum but with some volatility, investors could wait for pullbacks and identify laggards to gauge a better entry level.

We expect the government to step up with growth stabilization policies, we do not however expect large scale stimulus but instead, we expect the government will resort to targeted stimulus and reforms to support consumer spending and ensure ample liquidity to rejuvenate private investment.

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.

Monetary policy: more reserve requirement ratio cuts

Another 2-3 reserve requirement ratio (RRR) cuts are expected, following the overall RRR cut in early January. Despite having four reserve requirement ratio cuts last year, overall adjusted credit growth has yet to show signs of rebound and edged down marginally by 0.1% to 9.5% y/y in Dec-18. Bank lending growth picked up momentum in December and is marginally up by 0.4% to 13.5% y/y in December due to higher short-term household loans and strong bill financing. With more liquidity easing and more relaxed approach to support bank loan growth, we expect overall credit growth will rebound in 1H19. While the government is driving for more lending to be given to private sector and small- to medium-enterprises, we think that banks are likely to remain selective in lending to private enterprises.

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

MSCI announced increasing the weight of A-shares in MSCI indexes. It proposed 1) to further increase the inclusion factor of A-shares in large caps from the current 5% to 20% in three phases (May, August and November 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. Since the consultation was 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%.

How should investors position?

Chinese equities market has rebounded strongly with 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 2018 of around 9x and has pricing in some positive signals. We forecast policies supportive of growth are implemented and provide cushion against downward growth pressure. As it will take time for supportive measures to work out, equities market should stay volatile in 1Q but there are select bargains an astute investor can take advantage of. Identifying laggards and entering at favorable prices to gain investment exposure will gain substantial returns in the long run. Going into 2Q, we forecast the market to stabilize and strengthen as policy easing measures kick in.

We continue to prefer three key investment themes namely: 1) beneficiaries of growth stabilization, 2) quality domestic plays and 3) defensive plays. Investors should also pay attention to beneficiaries of A-share internationalization. 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.

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