Thursday, 3 December, 2020 China Merchants Securities (HK) Co., Ltd. Strategy Report Hong Kong Equity Research 2021 Outlook: Road towards restoration Jessie Guo, PhD +852 3189 6121 [email protected] “Lives of great men all remind us, we can make our lives sublime. Let Edith Qian, CFA +852 3189 6752 us, then, be up and doing. With a heart for any fate, still achieving, still [email protected] pursuing; learn to labour and to wait”. Harrington Zhang, PhD - Henry Wadsworth Longfellow, A Psalm of Life +852 3189 6751 [email protected] Tommy Wong View on economic recovery +852 3189 6634 [email protected] The outbreak of COVID-19 sent global economic growth deep into negative Johnny Wong territory in 2020. Synchronised large-scale fiscal and monetary policies +852 3189 6357 prevented major economies from sliding into perennial recession. [email protected] According to the IMF, global GDP will contract by 4.4% in 2020 and rebound Yonghuo Liang +86 755 8290 4571 by 5.2% in 2021, but the pace of recovery will be uneven across countries. [email protected] We expect the US economy to have a relatively muted start next year, and Kevin Chen then followed by a brighter second half, while the Fed’s monetary policy will +852 3189 6125 remain abundantly accommodative throughout the entire 2021. [email protected] Felix Luo, PhD +852 3189 6288 We stay positive on China’s economic outlook, mainly driven by domestic [email protected] consumption and manufacturing investment. We expect a rather neutral Yiding Jiao, CFA fiscal and monetary policy stance. A Biden presidency will not +86 755 8290 8475 fundamentally alter the rivalry between China and the US, but more [email protected] flexibilities might be given to balance between political and commercial Leo Liu, CFA +852 3189 6117 interests. Biden’s coordinated approaches with allies imply that China will [email protected] face more sophisticated global landscape. This should force China to speed Hayden Zhang, CFA up technological upgrade and independence, and to focus on domestic +852 3189 6354 consumption and the quality and sustainability of economic growth. [email protected] Yun Wei +86 755 8373 2985 View on stock markets [email protected] We have been arguing since April that A shares and MSCI China Index Matt Ma should outperform other major markets. We are cautiously positive on their +852 3189 6394 [email protected] outlook mainly due to overall macro backdrop. However, the rally is Eric Siu expected to moderate; and a number of potential risks could even cause +852 3189 6395 meaningful corrections in near to medium term: 1). strong rally since April [email protected] has by and large factored in earnings recovery; the current valuations look Bryan Wang increasingly stretched. MSCI China Index trades at 16.7x forward P/E vs +852 3189 6711 [email protected] historical median of 12.5x. The next leg of performance will be driven more Crystal Li by earnings revision instead of further valuation expansion; 2). liquidity +852 3189 6122 inflow could moderate; 3). ADRs face headwinds of potential de-listing from [email protected] the US market; 4). uncertainties related to Biden’s China policy. Warren Dai, CFA +852 3189 6126 We expect Hang Seng Index, which is a laggard throughout the year, to [email protected] Clint Su deliver a better performance in 2021 with a range between 23,500 and +852 3189 6635 30,500 (equivalent to 11x to 14.5x forward P/E) due to the following [email protected] reasons: 1). travel restriction will be lifted in post-COVID era so that local Anbo Zhao economy has better chance to recover; 2). local financial and property +86 755 8285 2939 sectors take up heavy weights in the index. Pickup of business activities [email protected] should lead to re-rating of these sectors and local consumer names with Calvin Ng +852 3189 6176 suppressed valuations; 3). the secondary listing of ADRs will enhance the [email protected] weight of new economy stocks in benchmark indices and attract fund inflow; Steven Yang 4). secondary listed stocks might become eligible for southbound trading of +86 755 8323 5354 Stock Connect; 5). undemanding valuation. HSI trades at 12.8x forward P/E [email protected] vs historical median of 11.2x. Laurel Zhu +852 3189 6142 [email protected] To access our research reports on the Bloomberg terminal, type NH CMS <GO> 1 Thursday, 3 December, 2020 Investment summary View on global recovery In its latest World Economic Outlook published in October, the IMF expects world GDP to contract by 4.4% in 2020 and rebound by 5.2% in 2021, implying that the output level in 2021 would be 0.6% higher than 2019. However the pace of recovery is likely to be uneven across countries. 1). For advanced economies, economic output will contract by 5.8% in 2020 and rebound by 3.9% in 2021, leaving the economy 2.1% below 2019 level. The US is expected to experience smaller contraction in 2020 as the lockdown measures implemented are much less draconian than European countries. Southern Europe are likely to suffer larger and longer-lasting recessions than Northern and Western Europe, as the former (Italy and Spain) are heavily reliant on tourism sectors and have smaller fiscal buffer due to higher debt levels. 2). China will be the only major economy in the world to see positive growth in 2020. The economy will record an accumulated growth of 10.3% over 2020 to 2021. For emerging market and developing economies excluding China, growth is projected to be -5.7% in 2020 and 5.0% in 2021. 3). The ASEAN-5 is the only major economy outside China expected to recover to above pre-pandemic level in 2021. India could experience a record economic contraction in 2020. We believe the risk associated with economic recovery remains high. The strength of recovery ahead will be highly dependent on the pandemic infection rates and the roll-out of the vaccine, as well as continued support from governments and central banks. We expect more visible and certain economic recovery trajectory in 2H21 when the impact of pandemic gradually fades away. Positive factors: 1). Compared with the outbreak in spring, governments, hospitals and healthcare professionals are now better prepared with drugs, equipment and know-hows to tackle outbreaks and treat patients. Death rates have been falling even as cases are rising. Step up of mass-scale testing and tracing program reduced the necessity of stringent lockdown. Social distancing measures introduced by governments are less draconian and more targeted, reducing unnecessary hindrance to the economy. 2). Progress made in vaccine development helped to lift confidence, but the timeline remains uncertain and large scale manufacturing and distribution of vaccine is critical. 3). Certain economic activities, especially industrial production and construction, see less interruption by the outbreak, while consumer spending are supported by preferential fiscal policies across countries. Negative factors: 1). Excess liquidity could bring long-term issues. We believe policies will continue to play a crucial role in the next phase of recovery. Massive policy support by governments and central banks around the world have helped to restore confidence and prevent massive bankruptcy and layoff. High government debt level was inevitable to prevent a worse recession. However, previous crisis have taught us that tightening policies and withdrawing supports prematurely could deal another blow to the stagnant recovery. 2). Energy prices have stayed at trough levels for long, suggesting that global demand remains weak. 3). A number of major equity markets have reached record high albeit weak fundamentals, which implies asset-price inflation caused by abundant liquidity. A persistent loosening monetary policy could distort proper allocation of social resource. 4). It is noticeable that the gap between the rich and poor has widened. To access our research reports on the Bloomberg terminal, type NH CMS <GO> 2 Thursday, 3 December, 2020 View on China economy We are positive on China economic outlook. CMS house view holds that: 1). GDP growth rate could bounce back to 9.1% in 2021E, with consumption and manufacturing investment as major driver. Our forecast is above Bloomberg consensus estimate of 8.2%. Quarterly GDP forecast are 17.9%, 7.8%, 6.5% and 5.4% respectively and 2020-2021 CAGR growth is 5.5%; 2). CPI and PPI will rise 1.0% and 0.6% respectively with no significant inflation pressure; 3). property development will no longer be the major growth driver; 4). the overall policy tone for fiscal and monetary policy is likely to stay neutral, given the outlook of steady economic expansion and a shift of policy design from “counter- cyclical” to “cross-cyclical” (跨周期调控). The latter focuses more on dealing with longer-term issues and challenges faced by the economy which extend into more than one cycles; 5). RMB is likely to remain strong against USD. USDCNY could strengthen to 6.45 in mid-2021E, and 6.05 by the end of 2021E, as a result of US dollar index entering into long-term weakening cycle. PBOC recently signaled a higher tolerance for strong RMB. Major downside risks could come from the following: 1). infrastructure investment falling short of expectation, due to constraints on local government’s fiscal resources; 2). property development investment no longer a driver due to new policies of “three red lines” to better regulate financing and leverage ratio. Since 2018, growth rate of property development investment has remained above overall fixed asset investment.