GDP/Earnings Downgrade in
View of the Poor PMI
ECONOMICS AND STRATEGY
Massive headwind, crisis valuation and
resilient market?
■ The headline PMI for October fell to its lowest level of 44.6. We have
revised our GDP growth forecast for 2008 to 8.7% and 2009 to 7.2%. GDP
growth for 4Q08 could be as low as 5.8%. We think China is likely to slip
into deflation. In our view, this round of five consecutive years of 10%-plus
GDP growth is over. We expect three to five years of sub-trend growth,
until the next “super factor”, possibly rural consumption, emerges.
■ There is a good chance of an earnings decline for China in 2009, and the
current consensus forecast of 12.4% growth for MSCI China is simply too
high. CS analysts have reviewed their earnings forecasts and the 2009
earnings estimates for stocks in our coverage universe are reduced by
14%. This translates into a 6% earnings decline for our coverage universe.
■ The trailing P/E and P/B of MSCI China, at 8.7x and 1.5x, respectively,
is already approaching the levels during the Asian financial crisis,
while the Chinese economy has improved in many aspects. Based on
our DDM, even if we assume no earnings growth in 2009 and 2010, the
12-month fair-value of MSCI China is still 49% above the current level.
Accordingly, we think that the China market could be quite resilient to
the massive cyclical headwind.
■ We overweight sectors such as consumer, Internet, health care,
telecoms and insurance in our model portfolio. Our top three picks
among the China stocks are China Mobile, Ping An Insurance and Belle.

Massive headwind, crisis valuation
and resilient market?
Poor PMI triggered GDP down
The headline PMI for October fell to its lowest level of 44.6. New orders, new export orders,
import orders, and input prices all fell sharply. We revised GDP growth forecast for 2008 to
8.7% and 2009 to 7.2%. GDP growth for 4Q08 could be as low as 5.8%. We think China is
likely to slip into deflation. We expect the government to boost infrastructure investments and
launch tax benefits to address the slowdown. In our view, this round of five consecutive 10%-
plus yearly GDP growth is over. We expect three to five years of sub-trend growth, until the
next “super factor”, possibly rural consumption, starts to emerge.
Earnings growth forecast under pressure
Followed the GDP and inflation downgrade, we cut our growth forecast for industrial sector
earnings in 2009 from 7.9% to -5.1%. There is a good chance for earnings decline in the
overall China market in 2009. The current consensus forecast of 12.4% growth for MSCI
China is simply too high and there will be more earnings downgrade ahead. CS analysts
have reviewed their earnings forecast, and 2009 earnings estimate in our coverage
universe are reduced by 14%. This will translate into a 6% earnings decline for 2009 in our
coverage universe. Earnings for cyclical sectors, like materials, machinery and property
etc. are being cut most. Global commodity prices are also expected to be under severe
pressure given the importance of China demand for commodities.
Valuation at crisis level
However, valuations of the China market are already discounting a rather severe crisis.
Trailing P/E and P/B of MSCI China, at 7.4x and 1.5x respectively, is already approaching
the levels during the Asian financial crisis, while the Chinese economy has improved in
many aspects – corporate are more profitable and less leveraged, banks have been
recapitalized and the country has a much stronger external balance. Based on our DDM
model, even if we assume no earnings growth in 2009 and 2010, the 12-month fair value
of MSCI China is still 49% above the current level. Accordingly, we think that the China
market could be quite resilient towards the massive cyclical headwind.
Sector/stock picks and CS China Model Portfolio
In this market environment, we recommend investors focus on sectors/stocks that are less
susceptible to the economic downturn, and it is still not the right time to go back to cyclical
sectors like commodities, shipping as well as exporters. We overweight sectors like
consumer, Internet, health care, telecoms and insurance in our model portfolio, and our
top three picks among China stocks are China Mobile, Ping An Insurance and Belle.
CS China sectors and regional views
In view of slower China growth and our official forecast change, 16 of our China sector and
regional (strategy, technology, thermal coal, Korea and Taiwan) research teams have
contributed their views (pages 19 to 84) and highlight any impact on their respective
coverage.