Credit Suisse Asia Equity Focus Chinese economy moderates further

China growth continues to moderate as policy normalization continues
China's latest set of economic data suggest that industrial production growth for July is in line with expectations at 13.4% year-on-year (YoY) but is slightly lower than June's reading of 13.7% YoY. Fixed asset investments growth also softened slightly in July to 24.9% YoY compared to 25.5% YoY in June. Retail sales also moderated in July to 17.9% YoY from June's 18.3% YoY. While the figures are softer, they are very much as expected and did not shock the markets any further. Meanwhile,

The CPI figures for July rose to 3.3% YoY from June's 2.9% YoY, and the amount of new yuan loans disbursed by the banking system eased to CNY 533 bn in July from June's CNY 603 bn. On the other hand, China's export and import growth figures slowed in July to 38.1% YoY and 22.7% YoY respectively. June's figures were 43.9% YoY for exports and 34.1% YoY for imports. Relative to the market consensus, the moderation in imports is greater than the moderation in exports and this resulted in an increase in the trade surplus to USD 28.7 bn in July from June's USD 20 bn.

Going forward, we expect a further moderation in the trade growth figures as the base of the previous year moves gradually higher. Also, the sharper-than-expected decline in imports suggests that production and consequently exports could moderate further in the coming months. Clearly, China is engineering a soft landing for its economy, which has been challenged by asset price inflation after the record credit extension in 2009. Looking ahead, we expect a further moderation in economic activity but not a drastic slowdown akin to a double-dip scenario. Under these circumstances, we continue to expect the authorities to normalize monetary policy but without any aggressive tightening as it soft-lands the Chinese economy to 9.5% growth in 2010.

On the equities front, both the Hong Kong and the China market may consolidate further today, following the weak US market overnight and concerns about China's slowdown. While our base case of a continued policy normalisation remains, investors may start to envisage a broader range of monetary easing by the Beijing government and expect additional liquidity to be injected into the financial system again if the forthcoming economic data points to a further slowdown. As such, barring any major further tightening or sharp economic crash (both seem unlikely), we believe this stock market consolidation will be modest and short-lived.

The increase in the investment ratio in stocks and mutual funds and in overseas markets by the China Insurance Regulatory Commission (CIRC) overnight also indicates the government's relatively accommodative policy stance towards the equity markets,
as theoretically CNY 600 bn capital will be allowed to enter the Hong Kong stock market.

After the HSCEI rebounds 10% within a month, it is not unusual for investors to take some near-term profits. We suggest long-term investors use this consolidation to increase positions in China equities ahead of the H2 rally, underpinned by the
undemanding valuation (HSCEI P/E 2010E of 9.5x, Shanghai Composite Index P/E 2010E of 14.5x) and strong earnings growth (20%-plus for 2010). We expect most interim results to meet or even beat the market's relatively low expectation, which should trigger a wave of market upgrades afterwards. Investors should increase the beta and our current China TOP PICKS include Angang Steel (347 HK, BUY), CNOOC (883 HK, BUY), China Construction Bank (939 HK, BUY) and China Railway Group (390 HK, BUY).