Comment: China'S Stock Market Will Continue To Outperform Global Emerging Markets In The Second Half

Wang Ying, China market strategist of Morgan Stanley

The outbreak of new crown pneumonia continues to rage around the world, which has an unprecedented impact on the global capital market. With the ability of timely and effective response and control, China quickly returned to production and work. Morgan Stanley predicts that China's GDP growth will reach 2.3% in 2020, which is likely to be the only country in the world with positive growth.

Based on our confidence in China's ability to cope with the crisis and the recovery of Chinese enterprises' profits, we explicitly raised the rating of Chinese stocks in global emerging markets in early March this year, and suggested that institutional investors should over allocate Chinese stocks in the emerging market stock portfolio. So far, the stock performance of Chinese listed companies has been satisfactory. By the end of August 2020, Mingsheng China Index (dominated by offshore Chinese stocks, with a share accounting for 12%, is the Chinese stock index tracked by the most global institutional investors) and the CSI 300 index have recorded growth of 18% and 19% respectively this year, significantly outperforming Mingsheng emerging market index (- 1%) and other major global stock indexes (8% for S & P 500, - 4% for Nikkei and - 7% for Minsheng Europe Index) ）。

There are three main reasons for the overall market confidence in China

After the year to date performance, we are still firmly optimistic that China's stock market will continue to outperform the global emerging markets for the rest of the year. Our confidence in the overall Chinese market is mainly based on the following three reasons.

First, the domestic macro-economy recovered steadily, forming a strong fundamental support.

According to Morgan Stanley forecast, China's economy has bottomed out in the first quarter of this year and rebounded from the second quarter. In the fourth quarter, it will achieve 6% growth, and the year-on-year growth of GDP will reach 2.3%. According to the latest tracking survey data of various industries, after the comprehensive recovery of production end in the second quarter, the recovery of consumption and service side has been in steady progress. We expect supply in the consumer and service sectors to return to pre epidemic levels by the end of the third quarter, while demand will fully recover in the fourth quarter. Our survey data show that at present, the supply side and demand side of the consumption and service industries have recovered to 90% - 95% and 85% - 90% levels before the epidemic respectively, and will fully recover before the end of this year. In addition, China's consumer activity index compiled by Morgan Stanley has continued to rebound from the lowest point in February, and has achieved growth for five consecutive months. This further confirms that the keynote of China's V-shaped rebound has been confirmed, and consumption and service industries will be the main force of recovery in the second half of the year.

At the same time, the company's earnings recovery is strong, earnings expectations upward correction momentum is sufficient. As of August 20, nearly half of the market capitalization of the MSCI China Index and about 20% of the market value of the constituent companies of the MSCI China onshore a index have released semi annual results. On the whole, the company's profitability rebounded significantly in the second quarter compared with the previous quarter, indicating that most companies have gradually stepped out of the negative impact of the epidemic on profits and revenue in the second quarter. In addition, Mingsheng China Index overall earnings forecast correction trend continued to rise. According to the historical experience of the index, this indicates that the current trend of profit improvement will have a greater probability to continue in the next few months.

We also have full confidence in the business of multinational enterprises in China. In addition, danshihua's index has been more optimistic for multinational enterprises in China in the second quarter. Over the past year or two, there has been some debate over the long-term investment of multinational companies in China. The above data can make us form a good judgment in the short and medium term.

Second, the proportion of the stock market in the new economy has increased year by year, and the overall market valuation is still attractive.

In terms of valuation, the MSCI China's 12-month forward-looking P / E ratio at the end of August was about 15.2 times, exceeding the previous historical peak (14.5 times at the beginning of 2018). We also fully understand the doubts and concerns of some investors about whether the market pricing is still reasonable. However, we believe that one of the main reasons for the rapid rise in absolute valuations in the past two years is the increasing share of new economy stocks (consumption, information technology, health care and media entertainment). The index weight of these companies in related industries has increased from 55% in early 2018 to 66% in the second quarter of 2020. The high growth attribute of these companies determines that their valuation and pricing will be higher than other more cyclical and defensive stocks, thus bringing about further improvement in the overall valuation of the Chinese market. Therefore, it should be said that it is not comprehensive to make a historical vertical comparison of the valuation of the market index.

Our analysis framework focuses on the comparison of China's overall market valuation and emerging market valuation. At present, the forward-looking P / E ratio of the MSCI China index is basically the same as that of the MSCI EM index. Therefore, we believe that the stock market should be in a relatively high rate of growth than China's stock market.

Third, the high penetration rate of online economy helps China's economy maintain resilience in the global epidemic situation.

The online economy, represented by e-commerce retail and online entertainment, has maintained steady growth in demand and profits during the outbreak of the epidemic, and has become one of the few industries less affected by the epidemic. The high penetration rate of online economy in daily life application scenarios does not need to be repeated. Thanks to this, China's economy is less affected by epidemic interruption and social isolation than other countries in emerging markets, and enables the economy to recover faster after the epidemic is effectively controlled.

As the main component of the new economy, the online economy represented by Alibaba, Jingdong, Netease, Tencent, meituan and other Internet companies has the attributes of high growth and high value. The weight of online economy related companies in Mingsheng China Index has reached 46%, far higher than 23% in emerging markets, which further supports the overall profitability and valuation of China's stock market.

Global institutional investors are enthusiastic about China's stock market allocation

For a long time, we have closely followed the allocation of China's stock market by institutional investors in emerging markets around the world. Compared with China's weight in the Mingsheng emerging market index, China has always been underpriced by institutional investors in the past 20 years. We think this is unreasonable. Since this year, the situation has improved a little. According to the data, by the end of July 2020, the allocation degree of institutional investors in emerging markets to China was 2.2 percentage points lower than the index, which was 0.5 percentage points higher than that at the end of 2019. This is consistent with our investment proposal, and also reflects the market's confidence in China's economic recovery and corporate profitability recovery.

More gratifying is that international investors' interest in a shares has increased. Compared with the nearly $19 billion of passive incremental funds brought about by the expansion of A-shares in the bright global stock index in 2019, every net inflow of foreign capital into the A-share market this year can be said to be "true love". By the end of August 2020, Beishang capital has accumulated a net inflow of about US $18 billion this year, of which only US $3.4 billion of passive funds (due to the expansion of the FTSE Russell Index A shares this year), and the rest are all actively increased holdings by foreign institutions. According to the statistics of the people's Bank of China and the stock exchange, by the end of the second quarter of 2020, the proportion of foreign capital in the circulating market value of a shares has reached a record high of 9.6%.

We believe that liquidity in China's stock market will continue to be adequate for the remaining four months of 2020.

In addition to the continued optimism about the inflow of foreign capital into a shares, we also note that since this year, the inflow of funds from Hong Kong stock connect to the south to Hong Kong Offshore Chinese stock market has remained strong. By the end of August 2020, the cumulative net inflow was US $55 billion, which has exceeded the annual net inflow of US $32 billion in 2019.

Our previous research shows that there is a positive correlation between the fund of Hong Kong stock connect going south and Hang Seng ah premium index. At present, the index continues to rise, so it can be judged that the Hong Kong stock exchange rate will continue to bring continuous liquidity support to the Hong Kong stock market. In addition, the Hang Seng Index company launched the Hang Seng technology index in July this year to track the leading technology companies listed in Hong Kong. In September, the Hang Seng Index and the Hang Seng state-owned enterprise index will also make major adjustments to their respective stock index composition and include more leading companies in the new economy. These market and index level reforms and innovations will drive the development and allocation of more ETF products and other stock index futures related products, so as to further attract diversified investment allocation and investment strategies, bring liquidity to the Hong Kong stock market and improve trading activity. As the main offshore platform for trading of Chinese listed companies, the improvement of Hong Kong's liquidity will benefit the overall Chinese stock market.

A-share landscape is better, it is suggested to over allocate a shares in the overall Chinese portfolio

Since May this year, we have continued to advise investors to over allocate a shares in the overall Chinese portfolio, and expect the A-share market to lead the offshore Chinese market in the second half. This is mainly due to the lower valuation level of A-shares compared with offshore stocks, less affected by geopolitical uncertainty, and some thematic investment opportunities unique to the A-share market. At the beginning of July, we further raised the target price of major stock indexes in China market, and expected that the A-share market represented by CSI 300 index has the largest upward space. This judgment is mainly based on the following reasons.

First, the valuation of a shares is close to historical lows compared with offshore Chinese stocks.

At the end of August 2020, the forward P / E ratio of Hushen 300 in December is 14.4 times, which has increased by more than 50% compared with 9.4 times at the end of 2018. But in terms of relative valuation, the CSI 300 is now 5.2% lower than the MSCI China Index. This shows that A-share valuation is more attractive than the offshore market.

Second, from the historical experience, the impact of geopolitical uncertainty on A-share market is far less than that of offshore market.

The proportion of foreign capital in A-share market is far lower than that in the offshore market, accounting for only 9.6% of the total free circulation market value of a shares, while the proportion of foreign ownership in the offshore China market represented by the MSCI China Index has reached nearly 40%. We have reason to believe that in the current geopolitical uncertainty, the external pressure on A-share liquidity will be less. In addition, from the past experience of Sino US trade frictions on China's stock market valuation and stock price performance, A-share has a more obvious safe haven attribute, and its valuation and share price volatility are significantly less than the offshore index (Hang Seng Index and Mingsheng China Index).

Thirdly, when the reform of A-share market structure is in progress, a series of unique thematic investment opportunities have gradually formed.

We predict that in the next five to ten years, there are two major trends that will drive the A-share market to further nurture long-term structural investment opportunities. First, urbanization 2.0. Combined with the new infrastructure construction and factor market reform, it is expected that China's urbanization rate will reach about 75% by 2030 by improving the urban population capacity and forming the agglomeration effect. Under this agglomeration effect, the coordination of industrial chain and knowledge spillover drive the per capita GDP to rise continuously, which makes China expected to surpass the middle-income and become a high-income economy in 2025. Second, the world has changed from unipolar to multipolar. China and the United States will compete in many fields, such as science and technology, security, medical policy, financial market and corporate governance, so as to develop their respective advantageous industries and leading enterprises.

? ? In such an internal and external environment, we summarized the following investment themes that can directly benefit from the above structural opportunities, including consumption upgrading, high-end manufacturing (robotics, automation, etc.), localization of science and technology industry chain (semiconductors, hardware, chips, software, etc.), new infrastructure (5g, Internet of things, digital infrastructure, new energy industry chain, etc.), defense and military industry, high-end manufacturing (robotics, automation, etc.), localization of science and technology industry chain (semiconductor, hardware, chip, software, etc.), new infrastructure (5g, Internet of things, digital infrastructure Medical care, etc. In the past few years, companies in these fields have shown a trend of choosing more A-share listing. In recent years, the implementation of the registration system reform in the A-share market, as well as the relaxation of restrictions on the listing of companies with different rights and vie structure, will further attract more high-quality assets to be listed and traded in a shares in the future.

In addition, as stated above, the focus of economic recovery and growth in the second half of the year will be shifted to the consumption and service industries. In the mid-2020 outlook report released in mid June this year, we have begun to suggest that domestic consumption and service should be oversupplied. At the same time, we continue to recommend the configuration of industries related to the online economic model, such as e-commerce, media and entertainment. The long-term structural changes of production and lifestyle during and after the epidemic ensure the certainty of growth for the relevant industries, which deserves continuous attention of investors.

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