MARKET OUTLOOK
Monthly market outlook for China and Asia region.
2018-4
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China

Economic data showed rather mixed signals in March. While Manufacturing PMI data rebounded to 51.5 (could be due to low base effect in 2017 amid New year holiday effect), Services PMI dropped marginally by 0.2 to 53.6. Other high frequency readings also pointed to further moderation of the economy.  Consumption of coal by major power generation groups fell to -3% YoY compared to +5% last month, while coastal bulk freight index has dropped by approximately 25% from its peak in January.  Retail sales stabilized at 9.7% in February (in line with consensus) and Fixed Asset Investment (ex-Rural) inched up from 7.2% to 7.9%. 

 

Despite concern of weakened macro data and potential Sino-US trade war, investors tended to wait for the results from the NPC meetings. Hence, after the rebound in late February, domestic A shares hovered in a trading range during the first half of March. Nevertheless, given there was lack of specific positive catalysts from the close of the NPC meetings, A shares started to decline in second half of the month. Apart from mounting tension between China and the US regarding trade dispute, further weaknesses in macro data and worries of more tightening measures on property sector triggered sell-off across the broad, with specific focus on large-cap counters.  In contrast, small-cap and growth plays bucked the trend and bounced back sharply in second half of March. In addition to encouraging comments from the government on supporting innovative sectors, the expectation for CDR from overseas listed vehicles initiated strong interests to growth plays. We noticed that investors switched from large-cap stocks to small-cap names (especially some ChiNext stocks) staring second-half of March.  In terms of sector performance, Healthcare sector sharply out-performed as investors chased for defensive plays which offered high earnings certainty.  Otherwise, all other sectors declined across the broad due to sell-off of most large-cap names.  Consumer staples, Cyclical and Financial stocks led the decline. In contrast to the tumble in large-cap universe, small-cap stocks rallied as investors gradually switched from previous out-performers to laggards.  Also, the policies of supporting innovative industries triggered strong interests in growth plays, irrespective of weak fundamentals and still high valuation.  

 

Unless there is dramatically change between the stances of China and the US, otherwise, worries of trade war will remain an overhang in the near term. Negotiation will continue and it may end up into a smaller scale of trade dispute, but it will inevitably affect the macro development of China. To cope with potential slowdown in economy, the State Council announced a tax cut package amounting to RMB 400 billion for 2018 (approximately 0.5% of GDP in 2017). Although the size of cut might have been smaller than some expected, it is still positive to those sectors being impacted.  With the completion of NPC meetings, near term focus will concentrate on implementation of all policies, which should be good for longer-term development. However, given de-leveraging and tight financial regulations remain the short-term target, we continue to expect a gradual slowdown in economic growth to happen in later part of this year. 

Since the broad market has come down to discount the negative impact from potential trade war, it likely to consolidate in the near term. Worries of slowdown in economy will continue to drag on sentiment, which capture any upside for cyclical plays, such as financials and materials names.  Although healthcare stocks offer high certainty in earnings, their hefty valuation provide limited upside near term.  As a results, despite weak fundamentals and still high valuation, investors may continue to chase up small-cap and thematic names given these stocks have under-performed the broad markets over the last year.

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Greater China Region

Greater China stocks consolidated by about 4% m-o-m in KRW (or down 2.2% m-o-m in USD) in March.   Off-shore China stocks led the decline amid concerns over US-China trade tensions.   HK stocks also underperformed within Greater China.  Apart from concerns over trade tensions, rising interest rate concerns post US Fed’s 25 bps rate hikes added pressures on HK properties.  Taiwan was resilient despite global volatility, thanks to the strong performance of key semiconductor stocks.   Our base case does not call for a fully-fledged trade war between the US and China.  The direct impact on China from the additional 25% tariffs of at least US$50bn imports from China to the US is limited. But the continuing tension and a probability of escalation would increase market volatility.   Corporate earnings continue to be positive as evidenced from recently released earnings and upbeat guidance.   Stock selection in sector leaders with solid earnings fundamentals should help mitigate looming macro risks.  

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ASEAN Countries

ASEAN markets were relatively resilient to contagion from US-China trade conflict and worries global growth will be undermined by an escalation of the conflict. The US-China trade dispute is not expected to escalate into a trade war although tit-for-tat trade sanctions are likely to persist in 1H18. ASEAN does not contribute significantly to the US trade deficit and is not at the forefront of the trade protectionism. Longer-term, ASEAN should attract more foreign investment with cost competitiveness enhanced by absence of import tariffs and increased urgency for China to grow intra-Asia trade. Short-term, ASEAN markets are likely to be more volatile as portfolio flows react to incremental US-China trade policy announcements. Active stock selection in companies with improving earnings fundamentals sold down on global macro should help to mitigate volatility risk.