Joining the dots of a cyclical recovery

March 2016 Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI(P) 124/04/2015 Deutsche Bank Markets Research Five key questions for Chinese equity investors in 2016 1. Why China may see a cyclical recovery in 1H16? 2. How will China implement structural reforms? 3. Why new economy stocks are core holdings? 4. What’s the best strategy under “New Normal”? 5. Which sectors and stocks to buy/sell in 2016? China Equity Strategy Chief China Equity Strategist, Yuliang Chang, CFA (+852) 2203 6195 | yuliang.chang@db.com Joining the dots of a cyclical recovery Markets Research Deutsche Bank Yuliang Chang, CFA | (+852 ) 2203 6195 | yuliang.chang@db.com March 2016 07/03/2016 16:51:17 2010 DB Blue template DOUBLE CLICK IN China Strategy: Joining the dots of a cyclical recovery 1  8% upside potential in 2016 with most returns front-loaded We expect H-shares to return 8% in 2016 thanks to a modest earnings growth pick-up and a slight valuation expansion. We target MSCI China/HSCEI at 64/10,000 by yearend 2016 We see most market returns front-loaded in 1H16, while 2H16 may face mounting downside risk  1H16 cyclical recovery gives room for 2H16 structural reform implementation We expect a cyclical recovery in 1H16 thanks to continuous destocking, improving demand and rebounding price levels. We think this may allow policymakers to implement more growth-negative structural reforms in 2H16  We see 4%/6% growth in 2016/17; domestic liquidity to remain abundant We estimate -5.6% earnings growth for MSCI China in 2015, due mainly to a significant drag from upstream sectors, and 4%/6% growth in 2016/17 on a modest pick-up in sales and margins  Valuations are deeply discounted; pendulum strategy under “New Normal” H-share 12m fwd P/E at 8.7x, a 24% discount to historical avg. We suggest adopting a pendulum-type strategy under “New Normal”: hold new economy and trade old economy  Implementation ideas: sector preferences, stock picks and thematic screens Overweight financials, IT and industrials, underweight telecom, energy and staples, and neutral on discretionary, utilities, healthcare and materials. Our 2016 top-10 picks include four new economy core holdings and six financial/cyclical names. Four thematic ideas: 1) preferred new economy stocks; 2) MSCI inclusion; 3) div. yield plays; and 4) stocks sensitive to the RMB Markets Research Deutsche Bank Yuliang Chang, CFA | (+852 ) 2203 6195 | yuliang.chang@db.com March 2016 07/03/2016 16:51:17 2010 DB Blue template DOUBLE CLICK IN Market outlook: We see front-loaded return in 2016 2  We expect MSCI China/HSCEI to reach 64/10,000 by end-2016  We see most market returns front-loaded in 1H16, while 2H16 may face downside risks: 1H16 market upside mainly comes from the gap of distressed valuations vs. our expected cyclical recovery Policy may shift priority to implementing structural reforms around mid-2016, which could drag near-term growth Source: Bloomberg Finance LP, MSCI, Deutsche Bank Strategy Research. All prices in this presentation are as of 4 March 2016 2016E2017ENow1H1620161H162016H-shares3%5%8.710.89.127%10%ADRs30%25%24.428.028.029%44%MSCI China4%6%9.411.910.827%16%Implied MSCI China target54716432%18%Implied HSCEI target8,558 11,608 10,023 36%17%EPS yoy (DBe)12m forward P/E (X)Implied upside Markets Research Deutsche Bank Yuliang Chang, CFA | (+852 ) 2203 6195 | yuliang.chang@db.com March 2016 07/03/2016 16:51:17 2010 DB Blue template DOUBLE CLICK IN Sector preference: We prefer financials, IT and industrials, and UW telecom, energy and staples 3 Overweight financials, information technology and industrials Underweight telecom, energy and staples Market-weight consumer discretionary, utilities, health care and materials Source: Bloomberg Finance LP, MSCI, Deutsche Bank Strategy Research Note: 5-year valuation z-score refers to the standard deviation from past 5-year historical average in terms 12-month forward P/E, except for financials who are based on 12-month trailing P/B. Index weightAdvised weightDiff.12m fwd P/E (X)12m fwd P/B (X)10-yr val. z-scoreOverweightMarket-weightUnderweightBanksInsuranceDiversified FinancialsReal EstateInfo. Tech.23%26%3%22.54.5-0.1Internet & SoftwareHardware & SemiconIndustrials7%10%3%8.90.9-1.1Capital GoodsTransportationAutomobilesRetailing & OthersUtilities4%4%0%9.21.2-1.9Water/Gas/Renew.IPPsHealth Care2%2%0%15.72.3-0.9Health CareMaterials2%2%0%15.10.90.9Construction MaterialsOther Basic MaterialsTelecom10%5%-5%12.41.3-0.3TelecomOil, Gas & ServicesCoalCons. Stap.3%1%-2%17.52.3-0.2Ho