More QE ‘China Style’

07 Mar 2016

China cut its reserve requirement ratio (RRR) universally by 50bps effective on 1 March 2016. The impact of this action is the release of about RMB680bn of liquidity into the banking system to stabilize growth. As discussed in our insights paper last year, we had expected that the People’s Bank of China (PBOC) would continue to use monetary easing tools to maintain stable growth and low costs of funding in continuation of “QE China Style”. The timing of the current cut highlights:

  1. Policy easing to continue before the National People’s Congress (NPC) meetings this month
  2. Maintenance of  financial stability and keeping interbank rates stable
  3. Room to ease with the currency (RMB) stabilized in the near term

Broad economic growth remains divergent in China with overcapacity weighing on investments and consumption-driven industry as the relative outperformer. Key concerns remain on asset quality risks and hence we expect “QE China Style” to continue, as additional liquidity is injected to ease the interest burden for both local governments and corporates, especially state-owned enterprises.

In the near-term market sentiment may be boosted by NPC policy announcements but longer term concerns remain over both macroeconomic growth and fundamental earnings. Valuations appear attractive with the MSCI China index trading at 9.4x forward PE vs 10-year average of 14.1x (see chart 1).

Chart 1: Valuations appear attractive

Source: Bloomberg, data as at 29 February 2016

However, given the continued risk of earnings downgrade and ROE erosion, we remain cautious and await earnings results later this month, to assess buying on conviction.

Whilst volatility presents opportunities, we need to assess the quality of each company especially for corporate governance risks. We still see opportunities in domestic demand and local consumption driven sectors, especially related to tourism and lifestyle spending as highlighted in the chart below.

Chart 2: Aggregate outbound tourists over time

Source: China National Tourism Administration, data as at 31 December 2015