20160912-高盛-Laggard_amid_a_rising_tide__China_back_to_OW__3liquidity_policy-driven_themes_17页_1mb

China: Back to Overweight Amid Rising Tide

Core Content

Goldman Sachs has upgraded its outlook on offshore Chinese equities (MSCI China) to Overweight from Market-weight, based on a combination of cyclical improvements, stabilized earnings, strong liquidity, and the relatively inexpensive positioning of China compared to other emerging markets (EM) and Asia-Pacific (APJ) peers. The firm highlights three key themes that investors should focus on to benefit from potential flow- and policy-driven upside.

Main Points

1. Upgrade Logic

• Cyclical Upturn: The Chinese economy has shown signs of recovery, supported by renewed policy easing and the potential for infrastructure investment (FAI) to grow from 12% to 20% year-on-year by end-2016.
• Stabilized Earnings: Corporate earnings growth has stabilized, with industrial profits increasing by 11% in July and NBS PMI suggesting a positive trend.
• Strong Liquidity: An equity-friendly environment is supported by a dovish Fed, RMB depreciation, and EM passive flows, which have offset active mandate outflows.
• Undervaluation and Catalysts: China is an inexpensive laggard relative to EM and APJ, and the launch of the SZ-HK Connect scheme is expected to boost sentiment and liquidity.

2. Key Themes for Exposure

• Heavy Index Weights: EM passive flows are expected to remain strong if the Fed maintains low rates. Large-cap stocks, especially in the technology and ADRs sectors, are favored due to their high index weights and underweight status by EM funds.
• High-Yielding Stocks: Onshore yield-chasing demand is supported by high-dividend stocks such as China utilities, HK/China financials, and real estate companies, which are attractive to institutional investors.
• Domestic Infrastructure Spending Proxies: Sectors with high sensitivity to infrastructure investment, such as utilities and industrials, are seen as beneficiaries of continued government spending.

Key Information

• 12M Index Target: Goldman Sachs has raised its 12-month index target for MSCI China to 70 from 60.5, implying a 9% upside.
• Performance: MXCN has gained 6% since the downgrade in December 2015, but has moderately underperformed APJ and EM by 5pp and 8pp respectively.
• Valuation: China's current valuations are at or above mid-cycle levels, with a 10% discount to EM and APJ peers.
• Investor Sentiment: The GSSRCERB index suggests risk appetite is at 1.5 standard deviations above the 120-day average, indicating a potentially high return environment.
• Fed Policy Uncertainty: The Fed's next meeting in September has a 40% chance of a 25bps rate hike, which could create selling pressures but also present a buying opportunity if a correction occurs.

Exhibit Highlights

• Exhibit 1: A list of stocks with high index weights and strong fundamentals, including Vipshop, China Life Insurance, PetroChina, China Mobile, Alibaba, Ctrip, Ping An Insurance, and others.
• Exhibit 2: Shows that activity growth has slowed, with structural imbalances remaining significant.
• Exhibit 3: Indicates that China's macro conditions have deteriorated over the past year, with challenges in growth, leverage, and credit quality.
• Exhibit 4: Highlights the high risk appetite and the market's recovery from its ytd troughs.
• Exhibit 5: Shows the market is pricing in a "lower for longer" Fed rate scenario.
• Exhibit 6: Demonstrates that Tech and ADRs have contributed significantly to MSCI China's performance and are still underweighted by EM funds.
• Exhibit 7: Lists high-yield stocks in the Southbound universe, including Huadian Power, China Power Int'l Dev, Wynn Macau, and Hang Lung Prop.
• Exhibit 8: Shows the compression of equity earnings yields and the appeal of yield-based investments.
• Exhibit 9: Highlights the potential for further allocations to Tech due to its favorable growth/valuation profile.

Conclusion

Goldman Sachs remains cautiously optimistic about China's equity market, emphasizing the importance of selectivity due to ongoing structural imbalances. While the market has shown resilience and a potential for recovery, investors are advised to focus on specific themes such as heavy index weights, high-yield stocks, and infrastructure beneficiaries to capitalize on the improved tactical backdrop.