Easing on Through 9 March 2016 Investment Themes Macro Policy - PowerPoint PPT Presentation

POLICY INVESTMENT MODEL Easing on Through 9 March 2016

Investment Themes Macro Policy Outlook Shift from currency stability at all costs to a balance of growth/liquidity support and currency stability Market Outlook The growth/reform mix looks positive for March, but worries and volatility will persist. Policy Investment Thesis Mix of long-term reform beneficiaries and short-term growth supports • Supply side reforms to disappoint (Steel, Coal) • Urbanisation (Property, Telco Operators, Insurance) • Financial reform (Insurance) • Consumer, market pricing (Healthcare, Telcos) 2 For full report, please follow link.

Growth policy: Reading the RRR cut • China’s RRR cut, although expected in March, came earlier than we thought (March 1) Its impact on key economic issues: • Growth – explicit sign that policymakers switching to pro-growth stance • Reform – As the Two Conferences begin this week, the RRR cut means the conversation can shift from supporting growth to structural reform • RMB – Outlook for gradual depreciation, not one-off devaluation as seen to risk SDR inclusion • Capital Outflows – Expected to slow after another $600bn leaves China. Will markets panic when reserves hit $2.6trn? • FX Reserves – With just $600bn of illiquid reserves & $2.6trn liquid, China can bear further outflows. • HK equities: Perception of reserves inadequacy could weigh on HK equities. 3 For full report, please follow link.

Monetary policy: China shifts to easing bias China’s Manufacturing PMI and Major Subindices PBOC Liquidity Injections vs Capital Outflows 60 2500 58 2000 56 1500 54 1000 Index RMB bn 500 52 0 50 -500 48 -1000 46 -1500 44 -2000 PMI Production New Orders Export Orders Total Capital Flow OMO RRR Unconventional liquidity • The PBOC has damped mounting speculative forces since mid-Jan, providing room for an RRR cut • PMI fell to the lowest since Nov 2011, which happened to be the start of an easing cycle • In late Feb, PBOC switched to a clear pro-growth bias and risk management (with bond maturities in March) 4 For full report, please follow link.

Monetary injections needed to offset capital outflows Outstanding FX debt: BIS, BOP Net Liquidity Injections vs Capital Flows 800 10,000 8,000 700 6,000 600 4,000 500 US$bn RMBbn 2,000 400 - 300 -2,000 200 -4,000 100 -6,000 - -8,000 01/2011 04/2011 07/2011 10/2011 01/2012 04/2012 07/2012 10/2012 01/2013 04/2013 07/2013 10/2013 01/2014 04/2014 07/2014 10/2014 01/2015 04/2015 07/2015 10/2015 01/2016 Short-term debt, BIS BOP: Major Other Assets 12m - Cap Flow 12m - PBOC 12m - Net New Deposits • Repayment of offshore loans and trade credit accounted for 48% of capital outflows in 2015 • With $300bn outstanding short-term external debt, assuming same mix, this implies $600bn (3.9trn yuan) of further capital outflows. • 5-6 50bp RRR cuts (690bn yuan each) would fully neutralise this outflow • Though may not be needed if bank deposit growth remains strong on fund inflows from WMPs etc 5 For full report, please follow link.

FX: China can survive outflows RMB Exchange Rate: US$ vs Trade Weighted Estimated Breakdown of FX reserves based on US Treasury data 135 5.8 $US(bn)� China� %� of� tot� Belgium� %� of� tot� Total� %� of� tot� 5.9 130 RMB appreciation Total� 1,817� 100%� 713� 100%� 2,530� 100%� 6 125 Of� which� Equity� 320� 18%� 34� 5%� 354� 14%� 6.1 120 Of� which� long-term� debt� 1,489� 82%� 666� 93%� 2,154� 85%� Index 6.2 … of� which� Treasury� 1261� 85%� 353� 53%� 1,613� 75%� 115 6.3 Of� which� Short-term� debt� 8.7� 0%� 13� 2%� 22� 1%� 110 … of� which� Treasury� 8.0� 92%� 10� 80%� 18� 85%� 6.4 � 105 6.5 100 6.6 Source: US Treasury, NSBO China CNY - Trade Weighted (BIS) USD/CNY • We believe China has only $600bn of illiquid reserves, ie room to run down reserves for a longer period of time than the market believes, even if capital outflows intensify. • China has ample liquid FX reserves: est $2.6trn (of $3.2trn total) vs $500bn decline in 2015 and peak $100bn/mth run-rate • IMF ARA; the claimed $2.6trn danger level comes from misapplication of the formula; it comes down to $1.6trn with capital controls – in any case this is a guideline not a hard- and-fast floor 6 For full report, please follow link.

PIM Performance vs HSCEI and MSCI China Performance Statistics for February 2016 Absolute return, % PIM HSCEI MSCI CSI300 Month -+1.2 -3.9 -1.4 -2.3 Quarter -10.3 -10.1 -14.7 -19.3 Annual -11.9 -35.0 -26.4 -19.5 Where did the relative performance in the February PIM come from ? • Water-H (+2.9%) and Property-H (+0.5%) both saw gains in February in a weak market as the sectors were seen as beneficiaries of easing to support growth. • Steel-H (-4.9%) and Coal-H (-4.2%) were both short positions and underperformed the index as the market came round to our view that overcapacity cuts would fail to have a significant impact. 7 For full report, please follow link.

Policy Investment Strategy Policy investment themes for March drive sector choices: Changes • Success (relative underperformance) of Steel and Coal SELL calls leads us to shift them to NEGATIVE Buys: • Telco Operators - H: China Mobile (941 HK), Unicom (762 HK), Telecom (728 HK) • Water – H/A: Tianjin Capital (1065 HK), China Everbright Intl (257 HK), Beijing Enterprises Water (371 HK), China Water Affairs (855 HK), Beijing Originwater Techno (300070 CH), Shanghai SMI (600649 CH), Chongqing Water (601158 CH), TUS-Sound Evnt (000826 CH), China Gezhouba (600068 CH), Tianjin Capital (600874 CH) • Healthcare – A: Shanghai Fosun (600196 CH), Shanghai Pharma (601607 CH) , Sinopharm (600511 CH), Kangmei (600518 CH), Beijing Tongrentang (60085 CH), Guangzhou Baiyunshan (600332 CH) • Property – H: COLI (688 HK) Vanke (2202 HK) , CRL (1109 HK) , Shimao (813 HK) 8 For full report, please follow link.

Water H/A – time to add holdings of this BUY Water sector touches on two major policy drives: Water-H Index and Industry Outperformance urbanisation and clean energy/environmental. 70 50% outperformance vs industry target 40% 60 30% Water investment +21% in 2015 to 725bn yuan & 20% 50 10% Index 0% • 46% above target of 1.8trn yuan in 2011-15 40 -10% -20% 30 -30% -40% 20 -50% Further consolidation expected of 340 water 10 -60% 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 Jan-15 Apr-15 Jul-15 Oct-15 operators; • 120 envt prot M&A deals (40bn yuan) in 2015 vss H Sector Performance (LHS) Industry Performance (RHS) • 88 deals (22.5bn yuan) in 2014 Water-A Index and Industry Outperformance Robust investment to be sustained: 100 50% outperformance vs industry target 40% • 20% hike in waste water treatment fee for non- 90 30% 80 20% residential users expected in 2016 70 10% 60 Index 0% • Expand on agricultural water reform pilots in 80 -10% 50 -20% 40 counties across 27 provinces. -30% 30 -40% 20 -50% • Implement irrigation water tariff reform over 10 -60% Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 2016-2020 focusing on capping water demand, introducing consumption quotas, and setting up a A Sector Performance (LHS) Industry Performance (RHS) water rights trading system. 9 For full report, please follow link.

Telco Operators – a BUY Telco operators – H are a BUY owing to a positive policy environment and relative underperformance Switch to 4G subscribers bringing higher ARPU: China Telco Operator-H Index and Industry Outperformance Mobile added 220m new 4G users in 2015 vs 90m in 2014. China Unicom and China Telecom have a 155 10% combined 113m 4G subscribers by January. outperformance vs industry target 145 5% 135 Tower sharing helps to reduce capex : 75% of newly 0% 125 Index built towers by the China Tower Holding Company are 115 -5% shared, saving 50bn yuan of capex last year. 105 -10% 95 85 -15% China started pilot programme of telco universal Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 service fund -the subsidy will account for 15%, 20%, 30% and 35% of the construction cost for eastern, H Sector Performance (LHS) Industry Performance (RHS) central, western and autonomous regions, respectively. Official target to complete broadband coverage in both rural and urban areas by 2020. 10 For full report, please follow link.