Our quarterly GDP growth outlook is a double-dip scenario. Following the first dip to around 6% in Q4 2008, growth may tentatively recover in H1 2009 but will likely slide again, until hitting the second trough in H1 2010.
We expect 2009 to witness the worst deflation in 10 years, with CPI inflation falling below -1% in February and PPI inflation declining to -7% in Q3.
Our top-down analysis suggests downside risk of 15-20ppts to the current consensus 2009 EPS growth estimate of 6% for the H-share index.
We believe the market will likely be range-bound in the next two quarters (from 8x to 13x 09PE), but a substantial rally may happen in H2 2009 (6-9 months ahead of GDP trough). Given this outlook, we will stay defensive in the near term (e.g., in H1 2009), and switch to a more aggressive asset allocation when signs of an end to analyst downgrades emerge -- hopefully by the middle of 2009.
For now, the key sectors we Underweight include banks, raw materials, dry bulk shipping, consumer discretionary and property. We Overweight telecom, oil refining, IPP, F&B, railway construction, healthcare, education and online gaming.
The following investment themes support our sector allocation strategy:
1.Deflation: negative for property, commodities, and banking, but positive for F&B, IPP, and oil refining.
2.Counter-cyclical services: healthcare, education, and online gaming should demonstrate significant resilience to the economic slowdown.
3.Consolidation: survivors in steel, non-ferrous, and property sectors will be important long-term beneficiaries of the ongoing industrialconsolidation.
4.Rural reform: electronics – ST beneficiary, rural consumption – LT winner.
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