China Strategy Spotlight:Joining the dots of a cyclical recovery

Deutsche Bank Markets Research Asia China Strategy China Strategy Spotlight Date 1 April 2016 Strategy Update Joining the dots of a cyclical recovery ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong 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. Yuliang Chang, CFA Strategist (+852 ) 2203 6195 yuliang.chang@db.com Joseph Huo Strategist (+852 ) 2203 6251 joseph.huo@db.com New orders minus inventory jumped in Mar 51.446.0-5-30 3 5 8 10 13 15 42444648505254565860Jan-12Apr-12Jul-12Oct-12Jan-13Apr-13Jul-13Oct-13Jan-14Apr-14Jul-14Oct-14Jan-15Apr-15Jul-15Oct-15Jan-16pptChina NBS manufacturing PMINew orders minus finished goods inventory (RHS)New ordersFinished goods inventoryNew orders minus inventoryjumped to 5.4ppt in March, the highest level since July 2014 Source: Wind, Deutsche Bank Strategy Research Power production growth spiked up in Mar 2 4 6 8 10 12 14 16 18 -30 -20 -10 0 10 20 30 40 50 Oct-10Jan-11Apr-11Jul-11Oct-11Jan-12Apr-12Jul-12Oct-12Jan-13Apr-13Jul-13Oct-13Jan-14Apr-14Jul-14Oct-14Jan-15Apr-15Jul-15Oct-15Jan-16yoy %yoy %Thermal coal consumption (avg. daily by 6 key IPP groups)Industrial production (RHS)Thermalcoal consumptionvs.IP Correlation = 77%Thermalcoal consumptionby IPPs spiked up in Mar, implying a rising IP Source: Wind, Deutsche Bank Strategy Research Short-selling remains elevated in HK 7.2%6.7%13.4%12.0%14.7%7.3%13.4%13.8%12.8%4% 6% 8% 10% 12% 14% 16% 7,000 8,000 9,000 10,000 11,000 12,000 13,000 14,000 15,000 Jan-12Mar-12May-12Jul-12Sep-12Nov-12Jan-13Mar-13May-13Jul-13Sep-13Nov-13Jan-14Mar-14May-14Jul-14Sep-14Nov-14Jan-15Mar-15May-15Jul-15Sep-15Nov-15Jan-16Mar-16HSCEIShort sell turnover as % of total (5-day MA, RHS) Source: Bloomberg Finance LP, Deutsche Bank Strategy Research What we are communicating to investors: cyclical recovery begins (p2~38) Our long-advocated cyclical recovery is unfolding – destocking in property continues while that of industrials may end; demand recovers due to strengthening credit creation, rising property/infra. new starts and resilient consumption; prices rebound across property, inflation and materials, especially for cement which is more sensitive to end-demand. Looking forward, we are watching: 1) potential pick-up in industrial production (due by Apr 15) and extended strength in bank loans/TSF (Apr 11/12); 2) MSCI China 2015 EPS came in line at -4.8% (non-financials at -14%), while leading indicators imply a rise in 1Q16 earnings; 3) ADR full inclusion to MSCI on May 31st – buy BIDU and BABA to gain from the event; 4) latest policy tone in the upcoming central politburo meeting in end-April. Performance and valuations: market rebounded in the “Hope” phase (p41~50) MSCI China rebounded 11% in March, outperforming Asia ex. JP, US, Europe and Japan. Brokers topped with 22% gain, followed by utilities and select cyclicals; defensives underperformed. MSCI China’s (ex. ADR) 12m forward P/E rose to 9.2x, but is still at 20% discount to historical average. Utilities, discretionary and financials trade near the bottom of their valuation range. The market rebound is mainly driven by valuation expansion, despite slight cuts in earnings, a typical “Hope” phase according to our “four phases” framework (see pages 25~27). A-shares gained 12%, led by brokers and ChiNext/small-caps. CSI300 12m fwd P/E is at 12x, with non-financials at 16.6x. Macro and earnings: transmission mechanism working well (p51~55) 1) February adjusted TSF growth moderated to 14.9%, but still expanded from the 14.6% in 2015, as overall monetary stance stays very accommodative; 2) inflation crept up to 2.3% in February on food price surge, core CPI actually dipped to 1.3% and we see low risk of stagflation; 3) new starts in property and FAI (planned investments in new projects) both jumped in Jan-Feb, suggesting recovering investments in the next few months; 4) 2M16 industrial profits rose 4.8% yoy vs. -4.7% in December, pointing to a potential rise in 1Q16 A/H non-financial earnings. MSCI China 2015 calendarised EPS declined 4.8%, in line with expectation. Liquidity and sentiment: H-share sentiment remains fragile (p57~60) H-share sentiment remains fragile despite recent market rally, for short-sell stays elevated at 13% of market turnover. Southbound connection continues to gain traction. As for A-shares, sent