China's NPC Takeaways and Implications

• China equities have rallied 15-30% in the first two months of 2019. However, this still leaves historical forward P/E and P/B forward valuations on both MXCN (China MSCI Index) and CSI300 near the lows seen since the GFC. 

• But for Chinese equity markets to rally further, corporate fundamentals need to improve and the stimulus (albeit restrained but better targeted) foreshadowed in the government work report (GWR) to China’s National People’s Congress by Premier Li Keqiang, serves as an important catalyst towards that objective.  

• Premier Li Keqiang’s annual Government Work Report (GWR) to China’s National People’s Congress (NPC) on 5 March 2019. Key highlights -

1. Lowers GDP target – GWR reduces China’s GDP growth target to “6-6.5%” for 2019, but indicates the government will still need GDP growth above 6.1% to ensure labor market stability.
2. More expansionary fiscal and monetary stimulus – GWR raises budget deficit target by 0.2ppt to 2.8% of GDP in 2019 accompanied by a 3% cut in VAT to reduce the corporate tax burden to benefit manufacturing, mining and wholesale & retail trade. On monetary policy, GWR plans to keep growth of M2 and TSF consistent with nominal GDP growth.
3. Structural reforms with better targeted investment – GWR underscores the government’s push for structural deleveraging, advanced manufacturing, SOE reform as well as the Belt and Road Initiative.
4. Bottom Line -  GWR puts the focus on investment and pro-growth measures even as the GDP growth target is lowered to 6-6.5% for 2019. Overall, the policy tone seems to turn more market-friendly, following a harsh year of ‘de-leveraging’ in 2018.

Takeaways and Implications:

• China equities have rallied 15-30% in the first two months of 2019, beating most expectations. The rally has been mainly driven by favorable central bank policies both overseas and domestically, positive development in US – China trade talks and the resulting correction of overly-bearish sentiment.

• Yet, while valuations have expanded across the board especially for sectors that have been hit most hard last year (consumer discretionary, tech hardware and healthcare), historical forward P/E and P/B valuations on both the MXCN (China MSCI Index) and CSI300 remain at or below their longer term averages from the time of the GFC.

• For instance, the MXCN longer term P/E forward valuation is currently sitting at its longer term average (September 2006 to current) at 11.6X while the CSI300 also at 11.6X, is significantly lower than its historical longer term average of 13.9X. The historical forward P/B valuations also show significant undervaluation with both MXCN and CSI300 currently at 1.5X against their longer term average of 1.7X and 2.1X respectively.  

• But for Chinese equity markets to rise further, corporate fundamentals need to improve and the stimulus (albeit restrained but better targeted) foreshadowed in the government work report (GWR) to China’s National People’s Congress by Premier Li Keqiang last week serves as an important catalyst towards that objective.  

Government Work Report (GWR): Key highlights

• Lower economic targets but impact limited -   A lower GDP growth target of “6-6.5%” for 2019, from “around 6.5%” last year is consistent with trade headwinds and domestic policy constraints. More importantly, the slowdown is expected to have limited impact on business sentiment as much of the headwinds have been already been discounted.

• Slower pace of investments but better targeted - GWR seeks to slow the pace but raise the quality of government-led investment with the focus on “effective investment” initiatives like Xiong’an New District and Greater Bay Area and the rural revitalization plan to boost infra investment growth. Beyond that, the plan is to lay the foundation for advanced manufacturing and modern services by promoting “information infrastructure”.

• A more expansionary fiscal policy -  GWR seeks a more proactive fiscal policy and raises the budget deficit by 0.2ppt to 2.8% of GDP. Within the budget, the central government’s investment spending is expected to rise 6.9%YoY and its transfer to local governments expected to go up 10.9%, both supportive of infra investment. GWR will also target fiscal measures to support sales of automobile and other durable goods and deliver “a larger scale reduction in taxes and fees” for the corporate sector (~RMB2trn vs. RMB1.3trn realized in 2018) that includes a 3% cut in VAT to benefit manufacturing, mining and wholesale & retail trade. 

• A more expansionary monetary policy - GWR plans to keep “the growth of M2 and TSF consistent with nominal GDP growth”. Accordingly, Citi analysts think M2 growth can grow above 8% in 2019 as the PBoC continues to ease credit availability.

Chinese Equity Strategy View

NPC’s fiscal boost, financial liberalization to support equites market     

• In the past, the impact of NPC on Chinese equities has been modest, in particular during the meeting period. After the meeting however, equities have tended to rise, with MSCI China and CSI300 gaining 4.3% and 3.2%, respectively one-month post the NPC, based on actual market performance since 2010. However, market performance this time around could be additionally boosted by a 3% cut in VAT which Citi analysts estimate could see China’s energy, household products, automobiles and capitals goods sectors raise net profits by up to 3%.

• A-share market opening-up - Citi analysts expect 2019 to be another milestone of A-share globalization with significant acceleration in A-share inclusion in global indexes. While not part of the NPC initiatives, such significant index inclusions by both MSCI and FTSE at the same time could introduce US$20bn of passive inflows to the onshore market in 2019 and up to US$100bn, taking into account active investors benchmarked to these indexes.  

 Infrastructure and financial sector supply side reforms an added boost

• With the government allotting an RMB2.15tn of local government special bond issuance in 2019, up from RMB1.35tn last year together with increased total social financing, a recovery in infrastructure investment growth is likely to benefit infrastructure-related stocks/ bonds (industrial / capital goods). Historically, the sector’s relative performance has been most positively correlated to China’s financial conditions.  

• GWR also seeks new investment in artificial intelligence, industrial internet, and Internet of Things. Key beneficiaries include Industrial loT that seeks to integrate information and operation technology in order to improve efficiency, aid product design and create new business models. This is seen as a major driver of China’s global competitiveness to allow it to move up the value chain and catalyze the transformation of its economy.

• Financial sector supply side structural reform to prepare for a further opening up of the financial sector. This would entail introducing more financial service providers including mid/ small banks, insurers, specialized FIs & foreign FIs to shift credit supply away from over-capacity sectors/ zombie companies/ overleveraged large corporates to channel credit more efficiently and help eradicate the problem of overleveraging.