Thursday, April 14, 2011

Investment Guide for 12th 5-Year Plan

Needless to emphasize, China's 12th 5-Year Plan must be your investment bible in these five years. That is why we have published quite a number of articles beforehand to outline the main points of this plan to you. However, how should investors wisely respond and make decisions in face of the 12th 5-Year Plan?

In fact, the plan itself is an useful investment guide to tell which sectors are worth investing. Before looking into this investment guide, let us brief the 2010 annual performance summary of China financial markets in Shanghai and Hong Kong first:

The Shanghai benchmark SSE Composite Index fell -14% YoY to 2808 at the close of year-end 2010, while the Hong Kong benchmark HSI (Hang Seng Index) gained +5% YoY to 23035 at the end-2010.

SSE Composite IndexHang Seng Index
end-2010 close280823035
% change (YoY)-14%+5%
Top Gainer (by sector)Non-ferrous MetalsRetails
Top Loser (by sector)SteelIndustrial Goods

These information should provide the ground for us to compare and review the overall performance of the below investment guide upon expiry of the 12th 5-Year Plan.

Now if you look carefully into the full content of the 12th 5-Year Plan, you should note that it basically encourages development on the following areas:

Domestic consumption; Education and Innovation; Research and Development (R&D); Strategic emerging industries; Government-subsidized low-income housing; "Three Rural" (agriculture, rural areas, and farmers); Agricultural irrigation and waterworks; "Three Networks" integration (for radio and television broadcasting network, telecommunications network, and the Internet); "Internet of Things" (IoT); Integrated transportation system (e.g.: high-speed rail); Cultural and software industries; and so on.

Although you may simply want to invest in all the above highlighted areas, we still prefer to formulate a more detailed investment guide on several major areas as below:

(1) Domestic Consumption:
For years, China depended on investment and exports to drive economic growth. In the 12th 5-Year Plan, China formally determined to rebalance its economy towards greater domestic consumption. It is the first time in history that domestic consumption is confirmed as a major economic momentum in any such national 5-year plan. Due to the central government support in this five years from 2011 to 2015, we decide to choose SSE consumer discretionary sector in Shanghai stock market (and also the related H-shares in Hong Kong and A-shares in Shenzhen) as our favorite sector for investment.

From macroeconomic considerations, owing to the robust growth of Chinese economy in these years, substantial improvement has been seen in both personal disposable incomes and corporate earnings, and is leading to the rise in local consumption. The 12th 5-Year Plan will also strengthen China's social safey net, which is another catalysis to encourage Chinese people to be more willing to spend their savings. Against such a backdrop, the stocks in domestic consumption related sector are set to outperform others.

Just for your tracking purpose, please remember the SSE Consumer Discretionary Index end-2010 was 2485 at the close, we will review the final outcome together with you upon expiry of the 12th 5-Year Plan.

Please note that we only look for opportunity to buy when there is a sharp stock price correction since most quality stocks in the consumer discretionary sector are now with a high price/earnings (P/E) multiple of more than 25. We also have to exclude companies that sell or trade daily necessities in China. In fact, we already mentioned in our earlier article: No More loose Monetary Policy that stocks of utilities, electricity and coals would not be our 2011 picks. It is because any price increase in the daily necessities can worsen the skyrocketing China inflation and the Chinese central government has implemented price controls that would unavoidably reduce profit margins of those companies. By now, as you may also know, the central government has already extended price controls to cover the food as well.

(2) Construction Materials:
In China's 12th 5-Year Plan, construction and renovation of government-subsidized affordable housing for low-income people will reach 36 million. Together with many other infrastructure projects, it is believed that cement, steel and all other construction materials will be under high demand in this 5 years. Resources will be also placed on these industries to eliminate surplus capacity, promote restructuring, mergers and also technology innovation.

As a result, we would favor the A-shares and H-shares for the sector of construction materials in this investment guide. In the contrary, please be aware that we are not as optimistic on the properties sector which is somehow related to the construction materials. Our earlier article: How New National Eight can Cool China Property Market already expressed our concerns over the investment risk for SSE Properties sector in 2011.

(3) Strategic Emerging Industries:
The 12th 5-Year Plan also inject new impetus to the Chinese economy and emphasizes the development of strategic emerging industries. Therefore in this five years we would favor the sectors of strategic emerging industries including IT (Information Technology), energy conservation, environmental protection, biotechnology, high-end equipment manufacturing, new energy, clean and renewable energy, new materials and also new energy vehicles.

In particular, renewable energy is now even more popular and is considered more reliable and safer than nuclear energy, after the radiation leakage at Japan Fukushima Daiichi nuclear plant since the massive earthquake on 11 March 2011. Again, as many of them are red-hot stocks, please be reminded to avoid investing in companies with high price/earnings (P/E) multiple.

(4) Banking Sector:
This year, 2011, is the first year of China's 12th 5-Year Plan. For proper risk management, although Price-to-Book ratio (P/B ratio is commonly used to compare current market price to book value) of most mainland banks still look attractive, we have to be caution about the mainland banking sector especially in this year, since the China's "2011 Top 10 Focus Areas" has put managing liquidity as their first priority to curb inflation. Reducing liquidity, most commonly by reserve requirement ratio (RRR) hikes, will definitely lower the loan-to-deposit ratio of the mainland banks and will limit their profit growth. Now the reserve requirement ratio (RRR) has reached a historical high level of 20%.

Economic restructuring is another keyword for the 12th 5-Year Plan. President of Industrial and Commercial Bank of China (ICBC stock codes: for A-shares and for H-shares) mentioned during a press conference on 6 March 2011 that Chinese banks will have to transform their asset structure, services, profit model as well as business structure to support the economic restructuring. They will need to focus on 3 areas:

(i) Support energy-saving and environmental-friendly industries, and control credit to industries which already suffered from surplus production capacity.
(ii) Support small-and-medium-sized enterprises.
(iii) Develop more overseas operations.

We believe such transformation will lead Chinese banks to switch to businesses with lower profit margin during this five years, and will impose additional investment risk to the mainland banking sector.

In all, you are advised to think carefully and consider to wisely re-adjust your own China investment strategy according to the 12th 5-Year Plan. The investment guide stated above should be helpful for your consideration but is just for your reference only. Mr China, however, does not encourage any risky investment (especially margin trading), and so please read our risk disclosure and disclaimer statement for details before investing.

Related article(s):
China's 12th 5-Year Plan: Government Work Report Part I
Chinese Government Key Targets and Work Plan for 2011: Government Work Report Part II
Top 10 Focus Areas for Chinese Government in 2011: Government Work Report Part III


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