The Shanghai Composite Index (SCI) extended its rebound for a second day, posting a 2.2% gain yesterday (or 4.3% in two days) to 2,528 points on hopes of a policy relaxation, as the slowing Q2 GDP growth rate of 10.3% suggests a higher slowdown risk. Policy-sensitive sectors such as property, banks and basic materials outperformed. Trading volume also jumped by 50% day on day, making the rebound appear more convincing. The proposal of a mini qualified foreign institutional investors (QFII) scheme (allowing offshore CNY to invest in domestic A shares via Chinese brokers/fund houses in Hong Kong) and reports that local insurance companies were starting to bottom fish at a level of 2,400 were also interpreted as positive policy signals. The Hong Kong Hang Seng China Enterprise Index followed suit, gaining 1.74%.
In our view, the tightening measures launched in mid-April are starting to take effect and may become more obvious in the next two months. This should give the government more leeway and flexibility in its policy implementation in H2. However, a reversal of its tightening-biased policy stance is highly unlikely, although policy/credit normalization will continue via a multi-pronged approach, given the subsiding inflation pressure and rising growth risk. We think that the authorities will continue to curb credit extension and stick to their full-year target of CNY 7.5 trn.
Based on a local media survey, twenty-four major A-share fund houses reduced their equity position by 10%–20% in Q2. With a relatively high cash position currently, they may need to re-enter the markets when the uptrend is confirmed to avoid an underperformance. We believe the recovery momentum of the SCI could be further established if it manages to stay above 2,600. On the other hand, against a backdrop of strong economic growth in H1, we see a limited disappointment risk in the upcoming interim earnings. SASAC's recently released statistics suggest that state-owned enterprises already recorded YoY profit growth of 62% in H1.
We continue to believe that market liquidity remains abundant, with many investors still sitting on the sidelines waiting for a re-entry opportunity, backed by attractive valuations. As a traditional leading indicator, A shares' stabilization may eventually spill over into Hong Kong H shares. However, it is still worth noting that H2 2010 earnings/economic growth will inevitably slow on a YoY basis, due to the higher base in H2 2009 and the tighter credit environment starting from Q2 2010.
This may not be fully factored into the market, in our opinion. Despite our positive fundamental view on China equities, market sentiment could turn cautious again and may continue range-trading in the near term on worries of an economic slowdown and decelerating earnings growth. Investors should continue to closely monitor A-share movements in the next few weeks, as it seems increasingly likely that the bottom-building process may end earlier than we expect. We continue to suggest selectively adding undervalued A/H shares (China Construction Bank-H (939 HK, BUY), ICBC-H (1398 HK, BUY) and CNOOC (883 HK, BUY)) to position ahead of a more sustainable recovery in H2, while more risk-tolerant investors may now consider increasing the proportion of high-beta stocks (Jiangxi Copper-H (358 HK, BUY) and CSCL-H (2866 HK, BUY)).
Timothy Fung, Phone: +852 2841 4812, timothy.fung@credit-suisse.com
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