New Economy In China, A "Long" Story

    • Market skepticism amid macro slowdown and trade tensions overlooks pronew economy catalysts, e.g. steady earnings growth, favorable FX movement, policy support, reforms and opening up.
    • For new economy we are Overweight e-commerce, online games, tech hardware, F&B, healthcare, logistics, lodging.
    • Introducing our New Economy Model Portfolio of 8 conviction BUYs: Alibaba, Meituan, NetEase, Sunny Optical, ZTO, Meinian Onehealth, Silergy, Ausnutria.

    So many reasons: New economy constituents of MSCI China have risen 893% in the past decade (vs old economy: 100%). The PE and PB ratios for the new economy index (ex-Tencent) vs the old economy are now at 122% and 182% premiums, respectively (in line / below 5-year average: 119% and 266%). Now there are more positives: solid earnings growth; better outlook for trade talks with favorable FX movement expected; monetary easing and tax cuts that shore up confidence and benefit private companies; and the upcoming Fourth Plenum may bring more reform pushes.

    Structural changes may further support the market and new economy stocks in particular: higher foreign holdings of A-shares with emphasis on new economy sectors; launch of the STAR board; further MSCI inclusion; reform of ChiNext board of growth enterprises; and more new economy companies to be eligible for Stock Connect.

    The Sino-US trade dispute, the major external risk to China’s economy, is expected to settle into a truce, or even a more substantial deal, by year-end, in our view. Trade frictions cast a shadow on IT and consumer discretionary sectors. But our estimate shows that exposure to the US accounts for less than 1% of MSCI China constituents’ total 2018 revenue.

    We believe 2020E EPS growth of around 12% for MSCI China is achievable. Even in our downside case scenario, MSCI China’s 2020E earnings growth would still be around 11%, assuming 10-20% lower 2020E EPS consensus growth rates for sectors with the highest US revenue exposure and for those that contribute the most to MSCI China’s growth momentum.

    Risks: Escalating trade tensions, slower pace of rate cuts, delays in the government rolling out market-friendly policies and reform initiatives, weaker-than-expected growth, and tighter liquidity.

    Sector and stock preferences: For new economy, we are Overweight e-commerce, online games, technology hardware, Food & Beverage, healthcare, logistics and lodging. For MSCI China, we are Overweight consumer discretionary, IT, healthcare and financials, and Underweight materials. We introduce our New Economy Model Portfolio with 8 bottom-up conviction BUY ideas: Alibaba, Meituan, NetEase, Sunny Optical, ZTO, Meinian Onehealth, Silergy and Ausnutria. This reflects our strategy view: to increase exposure to the new economy in the long run.

    (This article is from China Renaissance.)