港股策略：2019年展望，只缘身在此山中

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LawofattractionHongKongstrategy:2019outlookWeremaincautiouslyoptimistictowardsmarketprospectsoverthecomingyear,giventhemarginalimprovementofmacroeconomicconditionsinChinaandliquidityintheHongKongmarket.Wepreferinfrastructure-relatedsectors,suchasrailway,portsandairportsandremainpositiveontheconsumersector,givengovernmenttaxcutsandstimulus.GiventhevaluationgapbetweendevelopedandemergingmarketsandadeterioratingoutlookontheAmericaneconomy,weseethelikelihoodofsubstantialcapitalinflowsintotheHongKongmarketin2019.Slightimprovementofmacroenvironment.Intermoftrade,thedetourofChineseexportsthroughHongKongissomewhatalleviatingthenegativeimpactoftheUS-Chinatradedispute,andweseeareducedriskoftariffsincreasing.TherisingcontributionofconsumptiontoGDPimpliessteadyimprovementsindomesticpurchasingpowerandweviewastructuraltaxcutonvalue-addedtax(VAT)asthemostdirectpolicytoboostdomesticdemand.Optimisticoninfrastructureandconsumption.Consideringthatthecentralgovernment'sleverageratioisrelativelylow,webelievethereremainsroomforfurtheraccommodativepolicyandexpectmorestatefinancingactivitiestoboosteconomicgrowth.Sincestimulatingtherealestatesectorhasdonelittletostabiliseemploymentordriverelatedconsumption,thegovernmentislikelytotargetkeyinfrastructureareassuchasrailway,portsandairportswithactivefiscalpolicy.Inaddition,giventaxcutsandfurtherpoliciesdesignedtoboostconsumption,wecontinuetoholdapositiveviewontheconsumersector.Attractivevaluation.TheaveragePBmultipleamongHSCEIconstituentstockshasdeclinedtoapproach1.0xthisyear,justhigherthanthatwitnessedin4Q15-1H16,whentheChinesedomesticeconomyandrenminbiwerebothunderpressureandunderperformedothermajoreconomies.Inaddition,thevaluationgapbetweendevelopedandemergingmarketsremainssignificantandweexpectthistonarrowascapitalflowsfromdevelopedmarketswithhighvaluationstomoreattractiveemergingmarkets.Givenitsrelativevaluation,expectationsofaweakerUSdollarandthepotentialforatruceintheUS-Chinatradewar,weholdacautiouslyoptimisticviewonliquidityintheHongKongmarketin2019.Mildmarketupside.Basedonourearningsassumptionsandvaluationestimation,wesetour2019targetfortheHSCEIat11,600,representing10.8%upside.SWSoverseasportfolio.WeremoveXiabuxiabu(520:HK–N-R),SunnyOpticalTechnology(2382:HK-Underperform)fromourportfolioduetoweakresults.Consideringpolicyuncertainties,wealsoremoveChinaMapleLeafEducation(1317:HK-BUY),SinoBiopharmaceutical(1530:HK-BUY)andChinaNationalBuildingMaterial(3323:HK–N-R)fromtheportfolio,andlowertheweightingofAnhuiConchCement(914:HK–N-R).Giventheirstrongresultsandpositivepolicyoutlook,weintroduceAntaSports(2020:HK-BUY),GuangfaSecurities(1776:HK-Outperform),NewChinaLifeInsurance(1336:HK-BUY),ChinaMerchantsBank(3968:HK-Outperform)andChinaCinda(1359:HK-BUY)intoourportfolio,andrisetheweightingofChinasoftInternational(354:HK-BUY)aswell. 7December2018StrategLawofattractionReviewof2018Lookingbackon2018,weviewtrade,investmentandconsumptionasthemostchallengingareasforChina'smacroeconomy.Trade:Exportgrowthcontinuedtoimprovein2017,howevertheUS-ChinatradedisputedeterioratedrapidlyfromMarchtoSeptember,andthemarketwaspessimisticaboutexports.However,growthhasnotdeclinedsincethethirdquarter,outpacingmarketexpectationsfromJulytoOctober.Manyobserversbelievethisisduetothefrontloadingofordersaheadoftariffs,andexportswillfaceincreasedpressureinthenextyear.Investment:Althoughrigorousde-leveragingmeasuresandasharpdeclineinM2growthin2017signalledadeclineininfrastructureinvestmentgrowthin2018,thecontractionfromnearly20%tobelow4%duringtheyearstillexceededmarketexpectations.Consumption:Thegrowthrateoftotalretailsalescontinuedtofallin2018,whilethecontributionofconsumptiontoGDPincreasedfrom4.1%in2017to5.2%inthethirdquarterof2018,ascommodityconsumptionhasweakenedthisyearwhileserviceshavegrownstrongly.Hence,theoverallpurchasingpowerofresidentshasnotweakened.Outlookfor2019ThelistoftariffsimposedonChinabytheUnitedStatescoversmostoftheintermediateandcapitalgoodsexportedbyChinatotheUnitedStates.IftheUSfurtherexpandedthescopeoftariffs,itwillhaveamoresignificantimpactonAmericanconsumption.Inaddition,wenotethat20.8%ofproductsintheUS$200bnlistdonothavethepossibilityofimportsubstitution,while13.3%productsinUS$16bnlistand6.8%productsinUS$34bnlistcanonlyimportedfromChina.Whilewebelievethatexistingtariffswillremaininplace,furtherexpansionisunlikely.Inaddition,therenminbiexchangeratehassoftenedtheblowtoexportsafteritsrapiddepreciationandsubsequentstabilisation.September-OctoberdatashowsasteepincreaseofexportstoHongKong,farexceedingthatofothermajorexportpartners.SinceexportstoHongKongmainlyconsistofvarioustypesofre-exports,weinterpretthisasadetour,whichcouldsomewhatalleviatethenegativeimpactofthetradedisputeonexportsgivenHongKong’sstatusasaseparatecustoms’territorywiththeUS.Basedontheabovefactors,ourmacroeconomicteamestimatesthatthetradedisputewill,atmost,leadtoadropof20%inthegrowthrateofgoodsexportstotheUSin2019.SinceexportstotheUnitedStatesaccountfor19%ofChina’stotalexports,thedirectimpactoftradedisputesonexportsislessthan2%.Giventhatexportsaccountforabout18%ofChina'sGDP,thegrowthofexportstoothermarketsaswellaspartialabsorptionbythedomesticconsumermarket,theoverallimpactoftradedisputesonChina’s2019GDPgrowthis-0.4%. Fig1:ContributionofgoodsexportstoChina’sGDPFig2:China’sexportmarkets,2018Others26%USA19%India3%EU16%S.Korea5%Japan6%ASEAN13%HongKong12%25%24%23%22%21%20%19%18%17%16%03/201209/201203/201309/201303/201409/201403/201509/201503/201609/201603/201709/201703/201809/201815%Source:CEIC,SWSResearchSource:Wind,SWSResearchImpactedbytheglobalfinancialcrisis,externaldemandhasturnedprotectionistandthemanufacturingindustrymusttransforminordertoadapt.Inourview,domesticdemandwillbecomeakeydriverofChina’seconomy.In2018,thegrowthrateoftotalretailsalesdeclined,whilethecontributionofconsumptiontoGDPincreased,indicatingthattheoverallpurchasingpowerremainsstable.Thedifferentiationbetweenthetwoshowsthatwhilecommodityconsumptionweakenedinthefirsthalfofthisyear,thegrowthrateofserviceconsumptionwasstrong,andoverallpurchasingpowerremainedresilient.Fig3:TotalretailsalesinChinaFig4:ContributionofconsumptiontoGDP6%15%5%13%4%11%3%9%2%7%1%10/201301/201404/201407/201410/201401/201504/201507/201510/201501/201604/201607/201610/201601/201704/201707/201710/201701/201804/201807/201810/20185%0%Totalconsumergoodsretailsales:YoYgrowthTotalconsumergoodsretailsales:YoYgrowth-1%ConsumptionexpendituresDomesticinvestmentNetexportsofgoodsandservices201620171Q-3Q187December2018StrategSource:Wind,SWSResearchSource:Wind,SWSResearchThehighestVATrateof16%mainlyincludes“salesandimportsofgoods”andareductionwillhelptodirectlyimproveconsumerpurchasingpower.Assuch,webelievethatloweringtheraterepresentsthemosteffectivepolicyforthegovernmenttostimulatedomesticdemand.Ourmacroeconomicteamestimatesthat2019retailsalesgrowthwillreboundby0.8%YoYto8.0%,andthecontributionofconsumptiontoGDPgrowthisexpectedtodropslightlyby0.1pptfrom5.1%in2018.TheChinesegovernmentpossessessignificantdeposits,andthereisenoughroomfortaxreductionfromtheperspectiveoffiscalpolicy.Itisestimatedthatthebudgetdeficitratefor2019willincreasebyabout0.5%,belowthetaxreduction.Thecomprehensivereformofthefiscalandtaxationsystemrequiresthecentralgovernment'sdeficitratetorise,andgiventhatthecentralgovernment'sleverageratioisextremelylow,increasedborrowingintheneartermcanbeexpected. Fig5:China’sfiscaldepositbalanceFig6:Governmentleveragecomparisons7,0006,0005,0004,0003,0002,0001,000040%(Rmbbn)30%20%10%0%-10%-20%250%200%150%100%50%199619971998199920002001200220032004200520062007200820092010201120122013201420152016201720180%7December2018Strateg01/201106/201111/201104/201209/201202/201307/201312/201305/201410/201403/201508/201501/201606/201611/201604/201709/201702/201807/2018FiscaldepositbalanceFiscaldepositbalance:YoYgrowth(RHS)ChinaJapanUnitedStatesEurozoneSource:Wind,SWSResearchSource:Wind,SWSResearchLocalgovernmentfinancingactivitieswillstillbesubjecttodeleveragingpoliciesin2019.Debtreplacementsince2015iscomingtoanendandthereisrelativelylittleroomforadditionalleverage.Theproportionofcentralgovernmentrevenuehascontinuedtorise,withthefullimplementationof“replacingbusinesstaxwithVATtax”.Thishasalsoledlocalgovernmentstograduallyshifttofiscaltightening.Assuch,keyinfrastructuresegmentsareincreasinglylookingtothecentralgovernmentforfinancing.Companiesthatareownedbythecentralgovernmentareexpectedtoincreasefinancingforhigh-speedrail,portandairportconstructionprojects.Fig7:Leverage:LocalandcentralgovernmentsFig8:Percentageofcentralgovernmentfiscalrevenueaspublicfiscalrevenue52%50%48%46%44%42%04/201407/201410/201401/201504/201507/201510/201501/201604/201607/201610/201601/201704/201707/201710/201701/201804/201807/201810/201840%Source:Wind,SWSResearchSource:Wind,SWSResearchInourview,threemaindriverswillaffectChina'sGDPgrowthprospectsin2019.Thefirstconsistsofchangesinexternaldemandandthelong-termeffectsoftradedisputes.Thesecondconcernsthebalancebetweende-leveragingandstablegrowthpoliciesandthethirdischangesbroughtbystructuraltaxcutsandshiftingconsumptionstructures.Netexports:ThedirectimpactoftheUS-Chinatradedisputewillbemorepronouncedin2019butwebelievethattheimpactisunlikelytobeassevereassomeinvestorsexpect.WeestimatethatthecontractionofexportsofgoodsandserviceswillreduceGDPgrowthby0.9%. 7December2018StrategConsumption:ThecurrentVATrateforgoodsis16%and6%forservices.Webelievethatthe16%VATrateforgoodsislikelytodecline,helpingboostrelatedconsumption.Renminbidepreciationmayalsoreduceexpendituresonoverseastourismandpoliciesdesignedtoexpandthedomesticconsumergoodsmarketmayalsoleadtoadeclineinoverseasspending.WeforecastthatthecontributionofconsumptiontoChina’sGDPgrowthratewillbe5.1%in2019.Investment:Webelievethatinfrastructureinvestmentwillreboundin2019,whilerealestateinvestmentgrowthwillfallslightly,andinvestmentinmanufacturingwillcontinuetoexpandatarapidpace.ThecontributionofinvestmenttoGDPgrowthisexpectedtobeequivalenttothe2018levelof2.2%in2019.Weforecastthat2019GDPwillincreaseby6.4%YoY,0.3pptslowerthanin18E.Fig9:SWSforecastsonkeyeconomicdataItems2018E2019E1Q192Q193Q194Q19GDPrealYoY(%)6.70%6.40%6.20%6.30%6.50%6.50%ExportsYoY(US$,%)11.50%6.50%-1.00%5.00%10.00%12.00%ImportsYoY(US$,%)17.80%8.00%5.00%7.00%9.00%11.00%FixedassetsinvestmentsYoY(%)5.60%5.20%5.30%4.90%5.00%5.20%ConsumergoodsretailsalesYoY(%)9.30%9.80%9.50%10.10%10.00%9.60%CPI(%)2.20%2.30%2.40%2.40%1.90%1.50%PPI(%)3.70%1.00%1.80%1.40%0.60%0.20%M2(%)8.50%8.80%8.60%8.80%8.60%8.80%Reserverequirementratio(majorbanks,%)Source:SWSResearch14.50%12.50%14.00%13.50%13.00%12.50%IndustryearningsandvaluationTheHangSengChinaEnterprisesIndexistradingat7.49x18EPE,belowits10-yearhistoricalaveragesince2008andonlyslightlyhigherthanonestandarddeviationbelow.Inaddition,theHSCEIconsensusearningsforecastdeclinedsignificantlyin2018,withthedegreeofreductiononlylowerthanthatseenin2008,2015and2016.Asweknow,Chineseeconomyisunderhugepressurein2008duetoglobalfinancialcrisisandin2015-2016ashighleverageburden.Sentimenthasclearlysufferedfromexpectationsofafull-blowntradewarandaslowingChineseeconomy.Fig10:HSCEIearningsforecastchangessince200720%15%10%5%0%-5%-10%-15%-20%TT+8T+16T+24T+32T+40T+48T+56T+64T+72T+80T+88T+96T+104T+112T+120T+128T+136T+144T+152T+160T+168T+176T+184T+192T+200T+208T+216T+224T+232T+240T+248-25%201820172016201520142013201220112010200920082007Source:Bloomberg,SWSResearch 7December2018StrategFig11:HSCEIhistoricalvaluationlevelsince2008Source:Bloomberg,SWSResearchHowever,atamoregranularlevel,valuationsacrosssectorsvarysignificantly.Givenweakrecentconsumptiondata,wemaintainourconservativeviewonconsumersectorperformancein2H18E.Figure12belowillustratesthat,thevaluationoffood&staplesretailandsoftwareservicessectorshasexpandedsignificantlyYTD,whileearningsforecastsremainlacklustre.Assuch,webelievethesesectorsarelikelytofaceheadwindsinthecomingmonths.Meanwhile,earningsforecastsforpro-cyclicalsectors,suchasmaterialsandenergy,andconsumerservices(particularlytheMacaogamingandeducationindustries)haveseenupwardrevisionsYTD,whilevaluationsremainunderpressureduetopessimisticmacroeconomicexpectations.Webelievetheinfrastructure-relatedmaterialsindustryisstillanattractivechoiceinthefollowingmonths,asthegovernmentcontinuestoimplementmoreinfrastructurestimulatingpoliciestosupportthemacro-economy.Intermofenergysector,ouroilandgasanalystestimatestheOrganisationofthePetroleumExportingCountries(OPEC)memberstateswillcontractoilsupply,drivingupBrenttoc.US$70/bblin2019.Ontheotherhand,tighteningenvironmentalrequirementswillboosttheattractivenessofnaturalgas,andweestimatethatChinawillimportmoreliquefiednaturalgas(LNG)fromoverseasmarketsinthefuture.Inaddition,thenationalfive-yearplanfortheenergysectorsuggestsopportunitiesforthegasstoragebusinessesandgasservicesproviders.However,giventhehighbaseeffectanddownwardpressureondomesticeconomy,weholdcautiousviewontheMacaogamingindustryin1H19. 7December2018StrategFig12:Earningsandvaluationchangesacrosssectors40%30%20%10%0%-10%-20%-30%-40%EnergyMaterialsConsumerServicesRealEstateCapitalGoodsCommercial&ProfessionalServicesPharmaceuticalsBanksHealthCareTransportationUtilitiesFood,Beverage&TobaccoInsuranceMedia&EntertainmentTelecommunicationServicesHousehold&PersonalProductsConsumerDurables&ApparelRetailingDiversifiedFinancialsAutomobiles&ComponentsSoftware&ServicesSemiconductorsTechnologyHardwareFood&StaplesRetailing-50%EarningsforecastchangesValuationchangesSource:Bloomberg,SWSResearchGiventhedownwardpressureonChina’seconomy,wepreferdefensivesectorssuchasconsumerstaples.Inaddition,taxcutspolicywillimprovethesectorfundamentals.Figure12illustratesthat,earningsforecastsandthevaluationofconsumerstaplessector,suchashousehold&personalproductsandfood&beverageindustrieshavebothdeclinedYTD,asthetotalretailsalesremainedweakthisyear.Ourmacroeconomicteambelievesthatretailwillreboundin2019,indicatingthatmarketsentimentonthissectorislikelyimprove.LiquidityWenotefromourroadshowsthatmanyoverseasinvestorshighlightedthattheUS-Chinatradewarandrenminbidepreciationweretheirtwomaininvestmentobstacles.Givenlowvaluations,expectationsofaweakerUSdollarandthepotentialforatruceintheUS-Chinatradewar,weholdacautiouslyoptimisticviewonliquidityintheHongKongmarketin2019.GiventheFed’sratehikes,emergingmarketcurrenciesandequitymarketshaveunderperformedtheUSYTD.Inaddition,uncertaintiesacrossEurope,suchasBrexit,theItalianbudgetplanandweaker-than-expectedEurozoneeconomicdata,havenegativelyimpactedonEuropeanstockmarkets.Fig13:MajorcurrenciesvsUS$10%0%-10%-20%-30%-40%-50%JPY/USDHKD/USDGBP/USDEUR/USDCAD/USDKRW/USDCNY/USDIDR/USDAUD/USDPLN/USDINR/USDRUB/USDTRY/USDARS/USD-60%Source:Wind,SWSResearch Fig14:Stockmarketnetinflowsindifferentcountries(US$m)80,00060,00040,00020,0000(20,000)01/201802/201803/201804/201805/201806/201807/201808/201809/201810/201811/2018(40,000)AllemergingmarketsDevelopedEuropeJapanNorthAmericaSource:EPFR,SWSResearchIntermsoftheHongKongstockmarket,sincemid-June,astherenminbidepreciated,overseascapitalhasslowlyexited,althoughthescaleofoutflowsislimited.Formainlandinvestors,southboundcapitalhasretreatedfromHongKongYTD,indicatingthattheHongKongstockmarketbecamelessappealingin2018.Bysector,mainlandinvestorsstillpreferHongKonglistedfinancials,althoughthenetinflowdeclinedsignificantlyin2018.TelecommunicationsandITwerealsotwosectorsfavouredbymainlandinvestorsin2017,yetpositionsdroppedsharplyin2018.Fig15:HongKongstockmarket’snetoutflowsaremildsincerenminbidepreciationinmid-June4,0003,5003,0002,5002,0001,5001,00050000.165(US$m)0.1600.1550.1500.1450.14006/201807/201808/201809/201810/201811/20180.13501/201802/201803/201804/201805/2018HKstockmarketnetinflowCNY/USD(RHS)Source:EPFR,SWSResearchFig16:SouthboundcapitalretreatsfromHongKongstockmarketYTD120100806040200(20)(40)(60)140(HK$m)13513012512011511010507/201808/201809/201810/201811/20181007December2018Strateg01/201802/201803/201804/201805/201806/2018SouthboundnetinflowHangSengAHPremiumIndex(RHS)Source:Wind,SWSResearch 7December2018StrategFig17:Mainlandinvestorspreferfinancials,althoughnetinflowsdeclinedsignificantly(HK$m)120100806040200(20)FinancialsTelecommunicationsITIndustrialsRealEstateHealthCareMaterialsEnergyConsumerStaplesUtilitiesConsumerDiscretionary(40)20172018Source:Wind,SWSResearchGivenitsrelativevaluationandexpectationsofaweakerUSdollar,weholdacautiouslyoptimisticviewonliquidityintheHongKongmarketin2019.Figure18showsthat,aftertheglobalfinancialcrisisin2008,thevaluationoftheMSCIEmergingMarketIndexrecoveredquickly,outperformingdevelopedmarkets.However,astheFedannouncedtoscalebackQuantativeEasingin2013andtheEurozone’sGDPreturnedtogrowthatthesametime,thehistoricalpercentileofMSCIUSAIndexandMSCIEuropeIndexoutperformedemergingmarkets,indicatingthatdevelopedmarketsbecamemoreappealingtoglobalinvestorssince2013.Webelievetherelativestrengthofeconomicgrowthhassignificantimpactontheperformanceofdifferentstockmarkets.IntermsofHongKong,theaveragePBmultipleamongHSCEIconstituentstockshasdeclinedtoapproach1.0xthisyear,justhigherthanthatwitnessedin4Q15-1H16,whentheChinesedomesticeconomyandtherenminbiwerebothunderpressureandunderperformedothermajoreconomies.TheforwardPEratiooftheHSCEIiscurrentlyonestandarddeviationbelowits10-yearhistoricalaverage,whichweviewasattractiveforHK-listedChinesedomesticcompanies.Fig18:MSCIIndexeshistoricalvaluationchanges100%90%80%70%60%50%40%30%20%10%01/200508/200503/200610/200605/200712/200707/200802/200909/200904/201011/201006/201101/201208/201203/201310/201305/201412/201407/201502/201609/201604/201711/201706/20180%MSCIEMIndexMSCIUSAIndexMSCIEuropeIndexSource:Bloomberg,SWSResearch 7December2018StrategFig19:Equityfundshistoricalnetinflowschanges(US$m)200,000150,000100,00050,0000(50,000)(100,000)11/200705/200811/200805/200911/200905/201011/201005/201111/201105/201211/201205/201311/201305/201411/201405/201511/201505/201611/201605/201711/201705/2018(150,000)AllemergingmarketsequityfundsNorthernAmericaequityfundsWesternEuropeequityfundsSource:EPFR,SWSResearchOurmacroeconomicsteamestimatesthattwocatalystswillerodenextyear,underminingtherelativestrengthofdevelopedmarkets,particularlythebullishUSstockmarket.Intermsofcurrency,weexpecttheUSDollarIndextodeclineto90bytheendof2019,giventhepotentialinterestratehikesbytheEuropeanCentralBank(ECB)anddownwardpressureontheUSdomesticeconomy.TheECBisexpectedtoimplementitsfirstratehikeafterthemiddleof2019,whichwillofficiallylaunchaslowcycleofseveralyearsofcontinuoustightening.FortheUSitself,thedownwardpressureontradegrowthandinterestratelevelswillgraduallyemerge.TheEurozoneeconomyiscurrentlygrowingataslightlylowerratebutisstillgenerallyrobust,coreinflationcontinuestoriseslowly,whichprovidesstrongsupportfortheECBtograduallywithdrawfromQEin2018,andthefirstinterestrateincreasetotakeplaceafterthemiddleof2019.Althoughpoliticalissues,suchastheItalianbudgetcrisisandpendingBrexitdealwillsometimesshockmarketsentiment,thefundamentalsofEurope,especiallycoreEurozonecountrieswillimprovegraduallyin2019.ItisexpectedthattheeurowillriseagainsttheUS$nextyear.TheUnitedKingdomwillofficiallyleavetheEuropeanUnioninMarch2019.AccordingtothecurrentBrexitdraft,theUKwillentera21-monthtransitionperiodthatendsattheendof2020.TheUKgovernmenthasshownanobviouspreferenceforasoftBrexit,soastomaintaincloserelationshipswiththeEUintheareaoftradeingoods.However,thecurrentdealstillmustbeapprovedbyWestminster,andTheresaMayisfacingahostileparliament.WeestimatethattheuncertaintywillpersistandtheBritishpoundwillremainweakinthecomingmonthsifWestminsterrejectsMay’sdeal.IfnegotiationsaresatisfactorilyconcludedortheUKrevokesArticle50,theeconomicuncertaintyposedbyBrexitwilldiminish,andtheexchangerateofthepoundwillgraduallyappreciate.Otherwise,weexpecttheUSDollarIndextodropsharply,giventheweightingsofsterlingandtheeuro.WiththeUSimposingtariffsandfurthertradepolicyuncertainties,thecontributionofexportstoUSeconomicgrowthwillcontract,impactingcorporatereinvestmentinthemid-term.Therisk-freeratehasrisenrapidlyandremainsatahighlevel,whichisexpectedtohaveacertainnegativeimpactoninvestmentandconsumption,andtheUSeconomywillfacerelativelystrongdownwardpressure.WealsonotethatthetermspreadofUSTreasuryyielddeclinedto37bps,indicatingthatroomforshort-terminterestratehikesislimitedandthustheFedwillmovemoreslowlyinthefuture.Since1990,aninvertedspreadhasonlyappearedtwice,beforetheinternetbubbleburstin2000andglobalfinancialcrisisin2007.Comparedwiththelasttwoincidences,theglobaleconomicoutlookismuchweaker,andtheUSbullmarketislookingfragile.AccordingtoPowell’sspeech,theestimaterangeofthelong- termneutralinterestrateisfrom2.5-3.5%,indicatingthatthecurrentfed-fundrateat2.25%is“justbelow”thebottomoftherange.Fig20:Limitedroomforshort-terminterestratehikesFig21:Fedfudsrateandofficialestimationsoflong-termrate25%20%15%4003002001000BP4.5%4.0%3.5%3.0%2.5%2.0%1.5%10%5%(100)1.0%(200)0.5%0.0%12/201204/201308/201312/201304/201408/201412/201404/201508/201512/201504/201608/201612/201604/201708/201712/201704/201808/2018(300)199019921994199619982000200220042006200820102012201420160%(400)FederalfundrateTermspread(RHS)MedianofFedofficial'sestimationsofthelong-termneutralfederalfundsrate2018FederalfundsrateSource:Wind,SWSResearchSource:Bloomberg,SWSResearchWeexpecttheUSDollarIndextodeclineto90bytheendof2019.EmergingmarketcurrencieswillbenefitfromtheUS$depreciationandtherenminbiexchangerateislikelytoreboundslightly.OurmacroeconomicsteamestimatesanexchangerateofRmb6.8/US$1bytheendof2019.Inaddition,althoughtheHongKongmarket’sweightingwithinglobalequityfundsincreasedslightlyduringthe2017bullmarket,itdeclinedtoahistoricallowthisFebruary.WebelievethisreflectsinvestorconcernsaboutChina’sdomesticeconomyandrenminbiexchangerate.However,giventhestablerenminbiexchangerateoutlookandthepotentialforatruceintheUS-Chinatradewar,webelievetheHongKongmarketatitscurrentlowvaluationwillbecomeattractivetooverseasinvestorsnextyear.Inaddition,bothMSCIandRussellarelikelytoincreasetheweightingofChinaA-sharesinMSCIEMIndex.Webelieveitwillpromoteglobalinvestors’interestinChineseassetsaswell.Fig22:HongKongmarketweightinghasdeclinedtoahistoricallow120,000100,00080,00060,00040,00020,00005.5%5.0%4.5%4.0%3.5%3.0%2.5%07/200502/200609/200604/200711/200706/200801/200908/200903/201010/201005/201112/201107/201202/201309/201304/201411/201406/201501/201608/201603/201710/201705/20182.0%7December2018StrategEquityfundsallocatedinHKHKpositionweighting(RHS)Source:EPFR,SWSResearchIndexforecastBasedonSWSanalysts’earningsforecastsandouroptimisticviewontheemergingmarketliquidity,weapplyan8.1x19EPEmultipleandarriveatour2019EHSCEIyear-endtargetof11,600,representing10.8%upside. 7December2018StrategSectorrecommendationGiventheweakmacroeconomicoutlook,weestimatethegovernmenttoacceleratethenumberofinfrastructureprojectsin1H19.WenotetheshifttoadomesticdemanddrivenmodelaftertheglobalfinancialcrisisimpactedChina’sgrowth.However,withincrementaldomesticdemandmainlyderivedfrominfrastructureandrealestateinvestment,theeconomyismoresensitivetofiscalstimulus.China’sdebttoGDPhasrisenrapidly,soaringfrom162%in2008to266%in2017.Asthegovernmentturneditsattentiontotargetingrisksinthefinancialsystemandbegandeleveragingin2017,thegrowthofinfrastructureinvestmenthascontractedsharply.Evenwithmarginalrelaxationofmonetarypolicyin2018,localgovernmentsarestillreluctanttofinanceinfrastructureinvestments.Giventhecurrenteconomicenvironment,webelievethecentralgovernmentwilladoptamoreactivefiscalpolicyin2019,andthegrowthrateofinfrastructureinvestmentwillreboundslightlyfrom2018.Fig23:Infrastructure,realestateandmanufacturingfixedassetinvestment(%)60%50%40%30%20%10%0%06/200406/200506/200606/200706/200806/200906/201006/201106/201206/201306/201406/201506/201606/201706/2018-10%FAIinmanufacturing:YoYgrowthrateFAIinrealestate:YoYgrowthrateFAIininfrastructure:YoYgrowthrateSource:Wind,SWSResearchGiventheincreasinghouseholdleverageratio,limitedpromotingimpactontheemploymentmarketandotherindustries,webelievethattoughrealestatepolicyisnotlikelytoberelaxedorevencancelled.WenotethatwhileChina’shouseholdleveragehasincreasedoverthepastdecade,anditsgrowthratehasacceleratedaswell.Currentlyithasexceededthelevelofemergingeconomies.Fig24:Householddebtas%ofGDPcontinuestoincreaseinChina100%90%80%70%60%50%40%30%20%10%03/200012/200009/200106/200203/200312/200309/200406/200503/200612/200609/200706/200803/200912/200909/201006/201103/201212/201209/201306/201403/201512/201509/201606/201703/20180%ChinamainlandDevelopedeconomiesEurozoneUKEmergingeconomiesUSHongKongJapanSource:Wind,BankofInternationalSettlements,SWSResearch 7December2018StrategOnJuly312018,thePoliticalBureauoftheCPCCentralCommitteeheldameeting,emphasisingtheneedtostabiliseemployment,finance,foreigntradeandforeigninvestment.Amongthem,stabilisingemploymentwasseenasthepriority.Currentlytheprivatesectorandself-employmentaccountfor85%ofChina'stotalemployment,whichisprimarilydrivenbytherapidexpansioninwholesaleandretail,leasingandbusinessservices,accommodationandcatering,residentialservicemaintenanceandotherservices.Comparedtotheseindustries,constructiononlyaccounts2.8%ofemploymentindividually.Therefore,fromtheperspectiveofstableemployment,stimulatingtherealestatemarketdoeslittletostabiliseemployment.Inaddition,risinghomepricesmayleadtolowerconsumptionandincreasingrents,whicharenotconducivetothedevelopmentofthecommercialandretailindustry.Fig25:EmploymentbreakdownbysectorIndustry20082017Privateenterpriseandself-employed:Wholesale&retail25.80%33.00%Privateenterpriseandself-employed:Manufacturing18.50%14.10%Privateenterpriseandself-employed:Rental&businessservices3.00%6.80%Privateenterpriseandself-employed:Accommodation&catering4.30%6.70%Privateenterpriseandself-employed:Residentservices,repair&otherservices3.80%5.10%SOE:Publicmanagement,socialsecurity&organisations5.70%4.30%SOE:Education7.40%3.90%Privateenterpriseandself-employed:Construction2.80%3.90%Privateenterpriseandself-employed:Transportation,warehousing&postalservices2.20%2.00%SOE:Health&socialwork2.40%1.90%SOE:Transportation,warehousing&postalservices2.10%0.90%SOE:Agriculture,forestry,animalhusbandry&fisheries1.90%0.60%SOE:Scientificresearch&technicalservicesSource:Wind,SWSResearch1.00%0.50%AsillustratedbelowinFigure26,therelationshipbetweenrealestatesalesandrealestaterelatedconsumptionhasshiftedfromdrivingconsumptiontoweakening,anditisevenextrudingotherconsumptionnow.Fig26showsthat,before2012,thegrowthrateofsalesofhousing-relateditemsandretailsalesbybusinessesabovedesignatedsizemovedinlinewiththegrowthrateofsalesareaofcommercialhousing.However,thecommercialhousingsaleshaslessofaboosttothehousing-relateditemsandwholeretailsalessince2012,indicatingthatthepositivespillovereffectofstimulatingrealestatehasdeclinedgraduallyoverthepastdecade.Fig26:Thespillovereffectofstimulatingrealestatehasdeclinedgraduallyoverthepastdecade60%50%40%30%20%10%0%-10%-20%2004-022004-092005-042005-112006-062007-012007-082008-032008-102009-052009-122010-072011-022011-092012-042012-112013-062014-012014-082015-032015-102016-052016-122017-072018-022018-09-30%Growthrateofsalesareaofcommercialhousing:YoYGrowthrateofsalesofhousing-relateditems:YoYGrowthrateofretailsalesbybusinessesabovedesignatedsize:YoYSource:Wind,SWSResearchInfrastructure:Webelieveinfrastructureinvestmentwillbecomeahedgingpolicyagainstfallingexports.However,giventhecurrentdeleveragingprocess,localgovernmentsareunlikelytoserveasaninvestmentdriverandthecentralgovernmentwillneedtofillthegap. 7December2018StrategConsideringthesignificantdeclineinPPIyear-on-year,itisestimatedthatinvestmentininfrastructureinvestment(excludingelectricity)in2019isabout6%YoY.Realestate:Webelievethegovernmentisunlikelytoaggressivelypromotetherealestateindustryandexpectedrealestateinvestmentgrowthtodropslightlytoaround6%YoYin2019.Manufacturing:Structuraldifferentiationwillbecomemoresignificant,andadvancedmanufacturinginvestmentisexpectedtocontinuetoexpandsubstantially.Weexpectthatthenominalgrowthrateofmanufacturinginvestmentin2019isaround7.0%YoY,whichisclosetothe2018level.Inaddition,giventhetaxcutsandmorestimulusorientedpolicies,westillholdpositiveviewontheconsumptionsector.Aswesaidpreviously,ourmacroeconomicsteamforecaststhegrowthrateoftotalsocialretailingtoreboundby0.8%YoYto8.0%.Giventhedownwardpressureonmacro-economy,weestimatetheconsumerstaplessectorwillremaindefensivenextyear,astheirvaluationleveldidnotrisesharplyinthisyear.Consideringtheconsumerservicesindustry’sstrongabilitytoabsorbemployment,webelievethegovernmentwillkeeppositivetoneonthedevelopmentofthisindustry.Weestimateconsumerservices,especiallyleisure,cateringandentertainmentserviceswillhavehighelasticityin2H19.Amongtheheavyweightfinancialssector,weprefernon-bankingsector,especiallybrokerageindustryasourtop-pick.TheHK-listedChinesebrokeragesectoristradingatanaverageof0.85x18EPB,representingahistoricallow.Webelieveassetqualityservesastheprimaryoverhang,andthemarketisconcernedaboutexposuretobaddebtforthestockpledgebusiness.Theprevioustroughvaluationofthebrokeragesectorwasat1.0xPBin2016,andtheaveragelevelsinceisc.1.2xPB.Inourview,thegovernment’scurrentpolicystanceislikelytosupportthestockmarket,whichwouldunderpinimprovementsinbrokerageandinvestmentbusinesses.Inaddition,animprovingmarketwouldrelieverisksstemmingfromthestockpledgebusiness,furthersupportingthesector’sprofitmargin.Assuch,weseevaluationsrecoveringintheshort-term.WeexpectChina’sbrokerstocontinueimprovingtheirbusinessstructuresandanticipatearelativelylooserpolicyenvironment,whichmayalsosparkavaluationrecoveryinthesector,andthereforeleadtopossibleROEenhancement.SWSOverseasPortfolioWeremoveXiabuxiabu(520:HK–N-R),SunnyOpticalTechnology(2382:HK-Underperform)fromourportfolioduetoweakresults.Consideringpolicyuncertainties,wealsoremoveChinaMapleLeafEducation(1317:HK-BUY),SinoBiopharmaceutical(1177:HK-BUY)andChinaNationalBuildingMaterial(3323:HK–N-R).Althoughweholdanoptimisticviewoninfrastructuredemandforbuildingmaterials,thepotentialeasingofsupply-sidereformswillaffecttheprofitabilityofbuildingmaterialscompanies.Therefore,welowertheweightingofAnhuiConchCement(914:HK–N-R)from10%to8%.Giventheweakeconomicoutlook,wealsolowertheweightingofGalaxyEntertainment(27:HK–N-R)by2%.Giventhehigherpotentialofatradewartruce,webelievetheTMTsectorwillbenefit,thusweraisetheweightingofChinasoftInternational(354:HK-BUY)by2%.Inconsumptionsector,weintroduceAntaSports(2020:HK-BUY)intoourportfoliowitha6%weighting,givenitsstrongresultandoutperformanceinitshigh-endbrandFila.Animprovingsalesmixhashelpedliftmarginaswell. 7December2018StrategInfinancialssector,non-bankingismostpreferredindustryacrossthefinancialsector.GiventheChina’scapitalmarketreformsanditsSOEstatus,weintroduceGuangfaSecurities(1776:HK-Outperform)intoourportfoliowitha10%weighting.Intermofinsuranceindustry,weintroduceNewChinaLifeInsurance(1336.HK)intoourportfolio.ItsrenewalpremiumsdroveGWPgrowthinthisyear,duetocompany’sstrategyoncontinuouslyclearinglowvaluebancassuranceandsinglepremiums.Meanwhile,theinvestmentassetshaveexpandedaswell.Coresolvencymarginratioandcomprehensivesolvencymarginratiowas268.33%and273.3%,allaboveregulatoryrequirements,withcorecapital,actualandminimumcapitalallhaveseenYoYgrowth.Since2018,localAMCnon-performingloan(NPL)acquisitionhasdecelerated,reducingcompetitionandloweringacquisitioncostsinthedistressedassetmarket.WeintroduceChinaCinda(1359:HK-BUY)asourtoppickinthisindustry.GivenCinda’sadvantageinNPLdisposals,competitionfromlocalAMCsislikelytodiminish,andCindawillmaintainrapiddistressedassetacquisitionswithenhancedpricingpower.Duetoitslowvaluation,webelieveCindaenjoysdownsidesupportandarepositiveonitshighdividendyield.Givenitsstableearnings,retailadvantageandprudentriskmanagement,webelieveChinaMerchantsBank(3968:HK-Outperform)islikelytooutperformpeersintermsofassetqualityandcapitalposition.Giventhatthepolicytargetforeconomicgrowthisrelativestable,therewillonlybepolicyfine-tuninginsteadofsubstantialstimulus,sowefavourtwokindsofbanks,thosewithaprudentassetportfolioandriskmanagementaswellasstrongcapitalpositionslikeCMB,andthosewithextremelylowvaluationsandaSOEbackgroundlikeChinaCITICBank(0998:HK-Outperform).Fig27:SWSOverseasPortfolioTickerNameWeightings0027.HKGalaxyEntertainment5%0354.HKChinasoftInternational6%0914.HKAnhuiConchCement8%0916.HKLongyuanPower8%0998.HKChinaCITICBank10%1109.HKChinaResourcesLand10%1336.HKNewChinaLifeInsurance8%1359.HKChinaCinda5%1530.HK3SBio7%1776.HKGuangfaSecurities10%2020.HKAntaSports6%3968.HKChinaMerchantsBank7%BABA.NAlibaba10%Source:SWSResearch