China: Themes and Strategy for 2012
From slowdown to recovery

Table of Contents
Macroeconomic outlook ................................................................... 6
A deeper qoq GDP trough in 1Q12 ........................................................................................... 6
GDP growth to accelerate to 8.6% in 2013 .............................................................................. 7
Property FAI growth to slow rapidly in early-2012 .................................................................... 8
2012 export growth to slow to 8% ......................................................................................... 10
Inflation to drop sharply until 3Q12 ......................................................................................... 10
3–4 RRR cuts to support 15-16% M2 growth ......................................................................... 11
RMB should resume appreciating from 2Q ............................................................................ 12
Modest fiscal easing in 2012 .................................................................................................. 13
Real estate policy: incentive for first-home buyers ................................................................. 13
Equity market outlook..................................................................... 16
We expect 2012 EPS growth to reach 10%, and upward EPS revision to start in 2Q ............ 16
We expect 25-30% upside potential for MSCI China index for 2012, with the PE multiple
expanding to 10.5 by year-end ................................................................................................ 17
Market will likely be choppy in 1Q, as negative news flow on weaker growth intensifies ..... 18
Sequential economic recovery from 2Q should begin to offer solid support for the market .. 19
Themes for 2012 and beyond ................................................................................................. 20
Sector valuations ..................................................................................................................... 22
Our top Buy list ....................................................................................................................... 23
Disinflation ....................................................................................... 26
CPI inflation will likely fall to 2.5% yoy in 2Q12 ...................................................................... 26
Power and oil refinery: earnings impact from relaxation of price controls .............................. 27
Raw material prices have declined and are unlikely to rebound any time soon ...................... 28
Manufacturing: earnings impact of lower input costs ............................................................. 29
Our disinflation basket and its performance during the previous disinflation cycle ................ 30
The property cycle ........................................................................... 32
Recent declines in property sales and prices .......................................................................... 32
We expect property prices to stabilize after another 10% fall ................................................ 33
We expect property FAI growth to slow to 13% in 2012 ....................................................... 35
Property slump could drag down GDP growth by 1-1.5ppts .................................................. 37
How much will other sectors be affected? ............................................................................. 38
Conclusion .............................................................................................................................. 39
Peak of China’s commodity demand ............................................. 40
China’s demand for commodities as a percentage of global total .......................................... 41
Comparison of per capita consumption is misleading ............................................................ 41
Cumulative commodity consumption is a better approach to demand projection .................. 42
China’s cement demand will likely peak in 2015 ..................................................................... 43
China’s steel demand will likely peak in 2017 ......................................................................... 44
China’s copper demand will likely peak in 2025 ...................................................................... 45
Per capita infrastructure length and urbanization rate are not a good guide ........................... 45
Conclusion .............................................................................................................................. 46
LGFV debt and impact on banks .................................................... 48
Quick re-cap of the LGFV issue ............................................................................................... 48
Local government bonds to refinance LGFV loans ................................................................. 51
Our view on how the LGFV issue should be resolved ............................................................ 52
Why government resolution will be politically desirable ......................................................... 56
Investment implications .......................................................................................................... 56
Informal lending and small business failure ................................. 59
Re-cap of informal lending ...................................................................................................... 59
We expect informal lending to be less of an issue in 2012 ..................................................... 60
Bank exposure to small firms and informal lending is minimal ............................................... 61
Government to formalize informal lending market .................................................................. 62
Market implications ................................................................................................................. 63
Luxury goods ................................................................................... 64
Chinese consumption has driven growth in the world luxury market ..................................... 64
Why luxury goods in 2012? ..................................................................................................... 67
Investment implications .......................................................................................................... 70
12th Five-Year Plans for sectors ..................................................... 71
Government plans for sector growth ...................................................................................... 71
Government policies ............................................................................................................... 74
Investment implications .......................................................................................................... 75
Appendix A ....................................................................................... 77