JPM - View from the Bund - China

JPM - View from the Bund - China

* Key investment theme: We turn more positive on the MSCI China, a stance we initiated in the last issue of VFB in early March, despite the index gaining 25% from its low on March 2. Fundamentals continued to move in the right direction, strengthening our conviction that the Chinese economy had bottomed out in 4Q08 in sequential terms. We are encouraged by the continued strength in domestic end-demand, especially the sustained recovery in property transaction volume and auto sales.

* The NBS-PMI moved above 50 in March, as we expected. We expect loan growth to stay strong and new loans to exceed Rmb7T for the full year. We already see reductions in all three key recovery risks: 1) deflation expectations; 2) policy complacency; 3) deteriorating exports, which have led to a meaningful increase in our FY09E earnings outlook, with our top-down FY09E EPS growth rising to 7.4% from -5.2% (vs consensus’ 3.5%). We believe the earnings risks for 2009 are on the upside. We stress that, while the monetary and fiscal stimuli-related FAI strength is important, domestic consumer strength is also key to driving the China recovery. The consumption-led economic recovery in China, if sustainable, could help further re-rate MSCI China, which at 43.6 is trading at 11x FY09E P/E. We expect it to reach 50, with the H-shares hitting 10,000 by end-09. At this level, we believe MSCI China should be valued at 12.5x forward P/E (still below 10-year P/E 13x average).

* What is changing: While strong property transaction volumes continue, property prices in some cities have started to rise.

* Information: The call for a “super currency” shows China in a difficult situation for FX reserve diversification.

* Non-consensus calls: We believe: (1) credit expansion has further room; 2) the government will increase residential electricity prices to fend off the risk of deflation expectations.