China - Still a bright spot;

We believe China remains a bright spot globally on the back of its strong growth potential, reflected in our economists recently upgrading their GDP forecasts to 9.4% and 11.9% for 2009E and 2010E, respectively, from 8.3% and 10.9%. We think the market concerns about a near-term “exit strategy” appear premature as the government remains pro-growth and real interest rates are still near the historical highs despite a significant re-leverging in 1H09.

We expect HSCEI and CSI300 to reach 16,800 and 4,300, respectively, by end-2010E, implying 44% and 36% potential price returns. The incremental upside from the new targets is mainly driven by our EPS growth rollover, but we believe the monetary policy will be the swing factor to valuations and hence equity returns. We set out two scenarios to model the potential market returns in different liquidity conditions.

We see investment opportunities emerging from the private service sector, including healthcare and education providers, as the govt undertakes deregulation to catalyze sustainable growth. Sectorally, we like domestic demand and would overweight banks, insurers, property around our core holdings of internet and solid consumer names.

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