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We evaluate the impact of a higher-inflation environment on China stocks:
■ Double-digit nominal GDP growth? With higher PPI, there is a good chance that China’s nominal GDP growth could surpass 10% in 2017, better than any year after 2012. There is no sign of margin deterioration of downstream sectors (IPPs an exception) despite the commodities-driven rise in PPI, while the closure of industrial output gap started to drive a rebound in industrial investment, which helped in keeping PPI high.
■ Upside earnings surprise. Based on previous experience, a double-digit nominal GDP growth in China would have earnings growth of almost 20% for non-bank sectors in China, higher than the current consensus forecast of high single-digit earnings growth for non-bank, non-tech stocks in China. We upgrade our index target of MSCI China and HSCEI to 73 and 11,500, respectively.
■ Winners and losers. Cyclical sectors like commodities and machinery are natural beneficiaries of the recovering industrial investment, which will benefit stocks like Anhui Conch and Weichai. However, in an inflationary and more volatile cost environment with rising interest rate, non-financial companies with strong pricing power, a healthy balance sheet and a cost structure with higher fixed cost component could benefit, such as Wuliangye and Alibaba. In the financial sector, insurance companies will benefit mostly from rising investment yields, we prefer Ping An considering its laggard performance. Big banks could also benefit from a rising rate environment, but most gains may end up in higher loan loss provision.
20170306 - Credit Suisse - China Market Strategy：Relation Delight.pdf
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