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3 Things To Know About China's Surprise Rate Cut
June 12, 2012

We look at 3 factors why Chinese equities could stage a comeback from its recent lacklustre performance.

Author : iFAST Research Team

Idea of the Week: 3 Things To Know About China's Surprise Rate Cut [8 June 12]

The People's Bank of China's (PBoC) surprise rate cut of 25 basis points and introduction of some interest rate liberalisation measures, effective 8 June, caught markets unaware. Markets were expecting some form of policy response over the weekend with most analysts expecting further cuts in the Reserve Requirement Ratio (RRR) with the release of industrial production and fixed-asset investment growth, retail sales, inflation and new loan growth seemingly set to exhibit further signs of a weak economic environment. In this week's edition of Idea of the Week, we look at 3 factors why Chinese equities could stage a comeback from its recent lacklustre performance.

1. Further Policy Response Likely

In spite of the implementation of "fine-tuning" policies over the course of the previous few months, the PBoC still has plenty of room to manoeuvre to boost its economy especially as the current year sees a once in a decade handover of power in Beijing which requires social stability (through economic growth & low unemployment) as one of the many pre-conditions for a successful and less trying event. Given the likelihood of disappointing economic data, due to be released over the weekend, for the month of May which will reflect a weaker-than-expected economy, we believe that further policy moves to support its flagging economy are likely from the PBoC.

Future policy moves are unlikely to constitute a massive stimulus package as was the case back in 2009 when Beijing unleashed a USD 586 billion stimulus package aimed at helping the country soften the effects of the financial crisis. Rather, Beijing is likely to stick to monetary measures such as cuts in the RRR and the interest rate level if the economy does worsen in the near future which would help release some of the massive piles of reserves back into the economy, stoking loan and economic growth.

2. Domestic Consumption Remains The Focus

Consumption is a key theme for China as it has the world's largest "middle class" population estimated at over 300 million. The recent affirmations from leading figures in the Chinese leadership towards rebalancing the Chinese economy with a focus on being consumption-driven has undoubtedly cemented the repositioning of the Chinese economy. The change in direction which will come about gradually, is likely to a certain extent to have played a part in some of the weakness seen in recent economic data and indicators. Nonetheless, we believe that the end-goal of a consumption-driven economy will only serve to sustainably benefit China greater than its current economic model of a manufacturing and export giant.

The reorientation of an export-led economy to one focused on domestic consumption is never an easy process, particularly so given today's global macro environment. While China continues to press ahead with reforms and embarks on its 'journey to consumption', investors should look beyond some of the traditional indicators and focus on data and indicators which reflect the health of the sector the Chinese government seeks to grow.

3. Low Valuations Continue To Provide Value

Chinese equities have been heavily undervalued over the past few years as the global macro problems afflicting the developed markets continued to suppress risk appetite and raise concerns over the health of the export-led economy. As of 7 June 2012, Chinese equities were trading at a PE of 7.6x based on 2013's earnings, representing potential upside of up to 84.1% based on a fair PE estimate of 14.0x. Despite the temporary sacrifice in the quantity of economic growth which has afflicted China's economy, the long term future and quality of China's economy is being secured alongside sustainable healthy profits for corporates in China, which will benefit investors who have the patience and can see beyond the short term repositioning bumps of China's economy.

With earnings expected to register growth of 12.3% and 10.5% in 2013 and 2014, Chinese equities represent extremely attractive valuations backed by healthy earnings while likely further policy responses has real potential to erase the market's deep discount and unlock tremendous value.

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