China Strategy China: Equity implications of the earlier-than-expected RRR hike

PBoC raised RRR by 50bp: This is the first notable policy move on the
monetary tightening front since the government adopted a relatively
accommodative monetary stance in 2H08.


• We expect China’s equities to be largely range-bound in the short
term: We believe the RRR increase is a signal that the Chinese
government will begin the monetary policy normalization earlier this year.
Authorities do not want to see a surge in liquidity in 1Q10 as has been the
case in the previous two years. On the other hand, banks are competing
with each other to front-load their lending even more this year on concern
of increasing tightening risks as of 2Q FY10. This may result in new loans
in January and February FY10 surging above Rmb1 trillion before starting
to drop by an earlier-than-expected March rather than April. In other
words, the positive drivers of: (1) a liquidity surge in Jan-Feb FY10; (2)
rising earnings momentum; (3) anticipation of Rmb appreciation as of 2Q
FY10; and (4) the expectation on the launch of A-share index futures in
three months may well be neutralized by: (1) a possible faster-thanexpected
rise in inflation, and (2) a possible earlier-than-expected tightening cycle in China.

• Switching from interest-rate sensitive sectors to defensive growth
sectors, sectors benefiting most from the real economic recovery and
the consumer discretionary sector. (1) We stay UW in the property and
insurance sectors due to continued policy tightening concerns. (2) We cut
banks from OW to neutral. While fundamentals still favor Chinese banks
in the medium term, we believe banks’ performance in the short term
could be hurt by a number of technical issues. (3) We further increase our
exposure to the defensive growth basket—internet, tissue and diapers, gas,
select consumer staples, and healthcare companies that are positioned in
sectors with low penetration rate and strong secular growth, and that will
likely be least affected by a potential monetary tightening. (4) We add
positions onto sectors that are leveraged to a stronger-than-expected
economic recovery in China. Last but not the least, we add weight onto
consumer discretionary sectors such as autos, retail, and sportswear.
[jp morgan]
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