Wang Ying, China market strategist at Morgan Stanley
Every December is the time for us to sort out our ideas and look forward to the coming year. After more than half a year of careful judgment on the overall market, based on the improvement of some early signals we have seen, we believe that the performance prospect of China’s stock market in 2020 is more positive than before, and we can expect the overall stock index to rise slightly. Taking MSCI China, which represents the offshore Chinese stock market, and CSI 300, which represents the A-share market, as examples, we expect the target prices in 2020 to be 85 and 4180 respectively, which means that there is 8% – 9% room for rise in the next year.
This paper will discuss some warming indicators, and also analyze and prompt the risk points, in order to provide an analysis framework, so as to maintain vigilance and sharp judgment in the rapidly changing external environment.
China’s economic growth may rebound, and the company’s profit growth is expected
Morgan Stanley’s global macro team judged that China, Asia and emerging markets will gradually recover from the global macro environment.
Looking ahead to China’s economy, the uncertainty of China US trade negotiations in 2020 will be slower than that in 2019. The easing of trade conflicts will not only help reduce the uncertainty of the business environment, but also help the existing economic stimulus policies to be transmitted more effectively, so as to help enterprises regain confidence.
Under the dual influence of reduced external environmental uncertainty and policy support measures, we expect that the GDP growth rate in the fourth quarter of this year will reach 5.9%, and the economic growth rate may gradually increase to 6.0% in the first half of 2020 and further reach 6.1% by the end of the year.
Despite the weakness of the real estate market, sound infrastructure investment demand and increased exports will help to balance the labor market and promote consumption. In order to meet the investment demand, in addition to bank lending, local governments will inject liquidity into the market by issuing special bonds. Therefore, we predict that the growth rate of broad credit will remain at 11% – 11.5% (now 11%) in the next 12 months. We are pleased to see that the 2020 special bond quota of RMB 1 trillion is issued in advance, which is conducive to the continuity of policies and will play a useful supplement at the key node of economic growth and stabilization.
Accordingly, the earnings of listed companies will show an increasing trend in 2020, but their prospects still need to be judged carefully. Taking Mingsheng China Index as an example, we expect 10% profit growth in 2020 and 2021. In addition to the global macro environment and the expectation that China’s economic growth will stabilize in the short term, our profit growth forecast for the next two years is cautious and optimistic compared with the previous one, for the following two reasons:
First, the inventory cycle bottomed out. From the change of finished product inventory level, the destocking cycle lasting for nearly three years is coming to an end, which will trigger a rebound in inventory and production activities.
Second, the RMB appreciated slightly against the US dollar. Since May this year, the RMB has been depreciating against the US dollar. The offshore China index is very sensitive to the change of exchange rate. The change of exchange rate is also an important reason for the continuous decline of profit expectation in 2019. However, the Morgan Stanley macro team predicts that the RMB exchange rate will gradually stabilize. Compared with the current exchange rate level, the RMB will appreciate by 2.4% against the US dollar to about 6.85 yuan against the US dollar by the end of 2020.
Of course, we also pay close attention to the trend of market profit expectation correction. At present, the downward correction trend still exists. In the fourth quarter, listed companies are still facing the pressure of profit expectation as a whole. If the market fails to correct effectively, it will put pressure on the expected growth of profits next year.
The current average price of Mingsheng China index is about 11 times the forward-looking P / E ratio in December, which is close to the long-term average. It is different from the undervalued value (compared with the current 20% discount) before the rapid rise of the market in January this year, and the space for further rise of valuation in the future is narrowed. The slowdown of trade conflict may lead to a short-term slight increase in the valuation level, but it can only be sustained by the improvement of the overall profitability of listed companies, otherwise it is difficult to last for a long time.
Another change worth looking forward to is that there may be net capital inflows into emerging markets in 2020. At the same time, there will be room for global investors to increase their holdings in China. In 2019, capital flight from emerging markets lasted for 27 weeks, and the total phased outflow reached US $46 billion. According to the judgment of Morgan Stanley’s global macro team, the dollar will weaken in 2020. Superimposed on the easing policies of major central banks around the world, capital will return to emerging markets. We have seen this phenomenon in recent five weeks, and the return trend will continue next year. At present, the positions of global investors in China have fallen to a relatively low level, and the space for additional allocation has been opened slightly.
adjustment of industry allocation under the stabilization of economic growth and the transformation of old and new kinetic energy
Due to the slowdown of macroeconomic growth and the uncertainty of trade negotiations, we have been advising Chinese stock investors on defensive industry configuration for most of 2019. Looking forward to 2020, Morgan Stanley macroeconomists predict that economic growth in emerging markets (especially China) will stabilize and rebound slightly. Most of our industry analysts are more confident about the market trend of their respective fields in 2020. Based on this, we have made corresponding adjustments to the industry configuration suggestions.
We raised the retail sector to over allocation. Benefiting from the strong growth momentum of e-commerce enterprises, the market’s profit growth for the retail sector is expected to bottom out at the end of 2018, and then rebound all the way up to now. Since the valuation peaked in September 2016, the sector has experienced a gradual valuation reduction for nearly three years, and the valuation has stabilized since August this year. We expect that the retail industry will walk out of a wave of rising valuation in 2020.
We raised the transportation sector to over allocation. The recovery of global economic growth is of great help to boost the demand of the centralized transportation industry, thus contributing to the rise of freight. The air transport sector is currently undergoing structural reform, including airport capacity restrictions on the supply side and the gradual relaxation of fare restrictions on major routes. From the demand side, the recovery of the economy will help improve consumption growth, thus driving the volume growth of air transportation. The expectation that the global oil price will remain stable in 2020 and the expectation that the RMB exchange rate will rise steadily against the US dollar are also conducive to the aviation sector in the transportation industry.
We lowered the public utilities sector to low allocation. Since the second quarter of 2018, in view of the increasing downward pressure on macroeconomic growth, we began to recommend investors to allocate more well defensive public utilities. However, looking forward to 2020, we will reduce the allocation of public utilities from more allocation to less allocation. From the historical performance of public utilities, this sector often loses the market in the upward stage of the economic cycle.
In the long run, we should find investment opportunities under the transformation of the old and new driving forces of China’s economy.
Looking back on the development process of China’s stock market with China’s economic progress, we roughly divide it into two stages: the first stage is from 2000 to 2007. After China’s accession to the WTO, China will speed up infrastructure construction to meet the needs of export and manufacturing development; The second stage is from 2008 to 2017. Under the background of the rapid popularization of mobile Internet and the increase of per capita disposable income, China’s consumption level and the scale of service industry have increased rapidly.
In the six years from 2012 to 2018, we have long recommended the sectors of over allocation consumption, information technology and medical health to investors. The main reason is that in the process of China’s economic transformation from investment and trade driven growth mode to consumption and service driven growth mode, these sectors focus on companies with early income, which is commonly known as the “new economy sector”. In early 2018, we reduced the overall risk exposure of these sectors out of concerns about the high valuation of new economy stocks and the uncertainty of external factors.
Looking forward to the future, we believe that the simple and direct way to distinguish new and old industries by plate classification will gradually sink and subdivide. With the promotion of urbanization, every sector will actively and effectively participate in it, which is no longer a simple “new old” distinction. China’s per capita income increase and consumption upgrading will be an irreversible trend. The development of new generation information technology (such as 5g) and the large-scale and modernization of agriculture will help urbanization 2.0 centered on the super metropolitan area. Therefore, those industries that catalyze the process of urbanization 2.0, no matter which industry sectors they belong to, will directly benefit from the multi-directional and large-scale market demand.
Compared with the urbanization 1.0 stage, the new urbanization in the next 10 years will provide market players with three major investment and development themes: the rise of industrial Internet, mature industrial digitization and new life in smart city.
Will global index companies continue to expand A-Shares in 2020?
For most of this year, we recommend investors to allocate more a shares, which is mainly based on the consideration of multiple expansion of A-Shares by international indexes and the trend of RMB exchange rate. In fact, in 2019, the A-share market took the lead in the world and became the best performing stock market in the world so far this year. Looking forward to 2020, we still look forward to the rising space of a shares, but believe that the impact of the expansion of the index and the weakening of the RMB exchange rate will be weakened. Therefore, the opportunity for A-Shares to continue to outperform the offshore market will be reduced. In the new year, we suggest paying attention to both A-share and offshore markets, so as to lose investment opportunities on both sides.
Why has the A-share market brought excess returns relative to the offshore market in recent years? We have summarized three key reasons. What will they be in 2020?
First, will global index companies continue to expand A-Shares in 2020? We believe that the probability of continuous capacity expansion in 2020 is not high. In February this year, when Mingsheng index company decided to implement the three capacity expansion plans in 2019, it pointed out that the future capacity expansion plan for A-Shares is based on the four major problems solved by Chinese regulators. These four aspects are: providing international investors with the choice of A-share risk hedging and derivatives tools, the operational challenges and risks brought by China’s A-share short settlement cycle, the holiday dislocation between China’s onshore stock exchange and land stock connect, and the execution and operational risks brought to international institutional investors by the lack of effective comprehensive account mechanism of Shanghai, Shenzhen and Hong Kong stock connect. At present, China has made some responses to A-share investment risk hedging tools. In early March 2019, HKEx and Mingsheng signed an authorization agreement to launch the futures contract of MSCI China A-share index according to market conditions after obtaining regulatory approval. But then we did not see further development. Therefore, we believe that in 2020, in addition to FTSE Russell’s A-share expansion plan in March, other international index companies are not likely to launch new A-share expansion plans. MSCI also pointed out in its news announcement on November 27 that it will not consider further improving the valuation weight of A-Shares until these four problems are effectively solved.
Second, will the floating RMB exchange rate have an impact on the offshore China stock index? There is room for a slight and gradual appreciation of the RMB against the US dollar in 2020 and 2021, which will benefit the profit calculation and investment return expectation of the offshore China stock index.
Third, in terms of valuation, are A-Shares more attractive than offshore Chinese stocks? We believe that the current relative valuation of A-Shares is not cheap. The forward-looking P / E ratio of Shanghai and Shenzhen 300 is 11.3 times, an increase of nearly 20% compared with 9.4 times at the end of 2018. In addition, the US dollar will weaken in 2020, which will drive the net capital inflow into emerging markets. Under such an environment, the offshore Chinese stock market will benefit more than the A-share market.
While transmitting Morgan Stanley’s forecast of China’s stock trend in 2020 to the market, we also emphasize several major risk points to investors. If one or several risk points come true, the market trend may develop in the opposite direction of our prediction. First, if the trend of RMB against the US dollar and the development of global credit easing policy are contrary to the prediction of Morgan Stanley macroeconomists, the overall performance of China’s stock market will be affected to some extent. Secondly, the Chinese government is not limited to the current defensive easing policy framework, but vigorously overweight monetary and fiscal policies. Then, A-Shares will probably outperform Chinese stocks in the offshore market. Third, China puts forward targeted solutions to one or more of the four major problems of A-share expansion pointed out by Mingsheng index company. Fourth, there may be structural changes in the allocation of A-Shares by pension funds and social security funds.
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(21st Century Business Herald)
