Monthly Market Srrategy
The Chinese economy is likely to slow in the fourth quarter as a result of deleveragingin old-economy industries and strengthening in financial supervisionfollowing the establish of the State Council Financial Stability and DevelopmentCommittee. The decline in China’s stock markets in November may be a sign of anupcoming economic slowdown. The rise in China’s 10-year sovereign bond yield and3-month SHIBOR rates suggesting China has tightened its monetary policy amidfurther U.S. rate hike in December. This may cap the upside for stock markets inboth China and Hong Kong in near term. However, there is a continuous inflow ofcapital from China via Shanghai and Shenzhen Stock Connects that helps reduce therisk of a sharp correction on Hong Kong equities. We therefore take a neutral viewon Hong Kong’s stock market in December with a trading range of 28,600-29,800 forthe Hang Seng Index.
Hong Kong stocks retreated from 29,800 level on Monday after China’s securities regulator reportedly suspended the approval of Hong Kong-focused mutual funds, which potentially slowed the pace of southbound money into Hong Kong stocks. Market sentiment was also weighed by losses in the mainland China markets which slid to their 3-month lows. The benchmark index was further dragged by internet giant Tencent Holdings (#700) and Apple-supplier AAC Technologies (#2018), after a sell-off in US high-flying technology stocks, resulting in a fall for 5 trading days in a row. Over the week, the Hang Seng Index dropped 792 points or 2.65% to 29,074.24, while the HSCEI slumped 3.9% to 11,449.43. The average daily Mainboard turnover was little changed at HK$130.7 billion, compared with HK$132.6 billion in the previous week.
Consumption has become the main driving force behind economic growth in China. The development of "Internet " hascreated new consumption patterns and consumption habits. China’s two-child policy and the catching up of economicdevelopment in western China and rural areas will sustain China’s growth momentum. The Belt and Road Initiative is gettingon track while supply-side reform advances. Although real estate policies have been tightening, China’s economic growth ratehas reached recent highs in 1Q17. There were signs that growth momentum slowed in early 2Q17, but the latest economicdata has showed strong signs again. In our view, GDP growth rate in 2H17 will be lower than that in 1H17, but the overalleconomy will be largely stable. Emerging sectors, in particular, will show strong momentum.
In addition to AAC Tech and Tencent which slumped 9.7% and 7.4% w-o-w, the top year-to-date gainers such as Ping An (#美高梅集团，2318) and AIA (#1299) also lost their steam, down by 9.9% and 7.5% w-o-w respectively. Those index heavyweights faced strong selling pressures as most of them had accumulated a lot of gains year-to-date, which triggered profit-taking actions by investors near the year end.
Monetary policy in China is expected to remain prudent and neutral. The authorities will step up comprehensive financialsupervision to prevent risks, but the banking industry will be granted a grace period and some of the enhanced regulations willonly take effect on operations being done after a pre-specified cut-off date to cushion the blow. Liquidity condition is expectedto be neutral and slightly tight. Inflation will be moderate. Given the fact that capital control is strengthening, economic growth issteady and interest rates are climbing, the value of the RMB is expected to stabilize. Optimistic economic data for the eurozoneindicates that the ECB is expected to adjust its quantitative easing measures, which will support the euro. Earnings growth,driven by satisfactory economic performance in the US, supports the valuation of US stock markets. Nevertheless, the releaseof Trump's planned tax cuts and infrastructure projects did not live up to market expectations. Even though the US Fed isexpected to shrink its balance sheet in a gradual and predictable way, the move will still bring uncertainties to the market. Weexpect that the likelihood of adjustments in US stock markets is on the rise for 2H17.
On the economic front, China and Hong Kong reported mixed set of macro data this week. China manufacturing PMI unexpectedly picked up at 51.8 in November, despite a crackdown on air pollution and a cooling property market that had been widely expected to weigh on the economy. In contrast, Hong Kong’s retail sales in October rose 3.9% y-o-y, falling short of market estimate of 4.9%. In addition, the export growth in Hong Kong slowed from 9.4% in September to 6.7% in October, also missing consensus’ 10.1%.
The advancement of mutual access between stock markets in Hong Kong and mainland China is bringing a positive impact tothe market, which benefits internet companies, emerging industries, high-yield stocks and the HKEX. Supply-side reform,state-owned enterprise reform and the promotion of the Belt and Road Initiative will boost industry and company performance,stimulating high growth for emerging industries amid economic growth slowdown in China. Overall profit growth of companiesunder our coverage is estimated to be 18.5%, 19.7% and 15.1% in 2017-2019, respectively, using weighted average of marketcapitalization. As the Hong Kong stock market has accumulated a certain level of growth, we expect that the Hang Seng Indexwill fluctuate in 2H17. However, bright spots can be found in some individual stocks and sectors. We are optimistic about thefollowing sectors: new energy (natural gas), internet, infrastructure, environmental protection, consumption (apparel, food andbeverage), and we believe that trading opportunities can be found in petrochemical, cement and construction materials,banking, insurance, gaming and machinery sectors.
Looking forward, investors may eye on the release of trade balance in China and employment situation in the US next week. The Hang Seng Index is expected to further correct to below 29,000 level as Tencent investors is likely to keep taking profit before the year end.