2015 12 3

2016
()

2016

2016 GDP
6.4%2015 6.9% 5%
5.8%

2 2016 7
1.5% 300 10%

2016
6.6

/2016
/

2016 2016 H/A

7%/10%
A

ADR MSCI
2016 MSCI 5%2015 -1%A
A

2015

ADR

+ 3
33%2016

A
MSCI A
(i) (ii) (iii)

, Ph.D

+86(10)6627-3324 chenjie.liu@ghsl.cn

: S1420511070002

2016 20 2015
21% 19 2016 12
31%

2015 12 3

Our 2016 macro and market views in one page

Exhibit 1: We expect global growth to modestly improve
while China slows further next year

HK/China

24000

7%

7%

3%

4%

MXCN

61

65

7%

7%

5%

7%

MXHK

13309

13100

-2%

-2%

5%

3%

CSI300

3600

4000

10%

7%

7%

4%

MXAPJ (US$)

419

425

6%

1%

5%

7%

S&P500

2103

2100

0%

0%

10%

7%

STOXX600

384

400

4%

-7%

8%

12%
17%
6%
1800
7%
Note (1): TOPIX EPS based on fiscal, not calendar, years; i.e. 2016 represents
the fiscal year ending March 2017.
Note (2): STOXX600 target is as of Sep-16, others are as of end-16.

Exhibit 3: We are overweight New China and defensive

sectors to start 2016

TOPIX

1602

Exhibit 4: Key themes: New vs Old China; Rmb hedges

Offshore (H shares, Red Chips, ADRs)

Overweight
Marketweight
Underweight
Tech/Internet
Insurance
Banks
Telecoms
Utilities
Cons. Disc.
Healthcare
Energy
Materials
Property
Onshore A shares
Overweight
Marketweight
Underweight
Healthcare
Industrials
Steel
F&B
Banks
Non-ferrous Metals
Media
IT
Coal
Tourism
Energy
Chemical
Software
Construction Materials
Property
Telecoms
Cons. Disc.

RMB depreciation winners relative to losers

'New China' stocks relative to 'Old China'
MSCI All China index

YTD perf
150
140

+28%

130
120

+10%

110
100

+1%
Oct-15

Nov-15

Sep-15

Sep-15

Aug-15

Dec-14

90

Jul-15

1.50
6.80

5%

22381

Jul-15

1.50
6.60

1%

Jun-15

2.0
4.1
0.2

6%

May-15

2.3
4.0
0.1

6%

May-15

6.1
3.7

CY17E

10500

Apr-15

6.0
3.5

HSI

CY16E

Mar-15

6.3

9948

EPS growth (%)

USD

Mar-15

Asia ex Japan
6.1
World
3.1
China real GDP growth contribution (PPT)
Gross capital formation
2.6
Consumption
3.8
Net exports
0.5
China's interest and exchange rates
7D repo rate (%)
2.00
USD/CNY
6.41

6.4

HSCEI

Potential +/- (%)

LOC

Feb-15

6.9

Index
Target
(End-16)

Jan-15

China

Current
Level
(Dec 1)

Index

2017
Current
forecast
2.2
1.6
0.7

Global/regional

GS Real GDP
US
Euro area
Japan

GS macro forecasts (% yoy)

2015
2016
Current
Current
forecast
forecast
2.4
2.3
1.5
1.7
0.6
1.0

Exhibit 2: We forecast high-single-digit price returns for

most China-related equity indexes in 2016

Exhibit 5: These 20 names collectively express our macro, micro, and thematic views
Ticker

Company name

Top-10 picks (onshore)

600196 CG Fosun Pharma
600535 CG Tasly Pharma
600519 CG Kweichow Moutai
002415 CS Hangzhou Hikvision
002008 CS Han's Laser Tech
300124 CS Inovance Tech
600340 CG China Fortune Land
601318 CG Ping An Insurance
601098 CG China South Publishing
000002 CS China Vanke
Top-10 picks (offshore)
688 HK
China Overseas Land
392 HK
Beijing Enterprises
941 HK
China Mobile Limited
700 HK
Tencent
2357 HK
AviChina
2186 HK
LUYE Pharma
VIPS UN
Vipshop
BABA UN
Alibaba
BIDU UW
Baidu
2313 HK
Shenzhou Int'l

Sector

Quoted
Price

Listed
3M
15-17E
market
ADVT
EPSg
cap
(US$mn)
(%)
(US$mn)

15E
PEG
(X)

15E
P/E
(X)

16E
P/E
(X)

15E
P/B
(X)

GS
Rating

Potential
upside
(%)

Health Care
Health Care
Cons Stap
IT
Industrials
Industrials
Financials
Financials
Cons Disc
Financials

CNY 24.5
CNY 36.1
CNY 213.8
CNY 33.8
CNY 24.0
CNY 44.2
CNY 27.2
CNY 34.1
CNY 24.3
CNY 16.6

7,301
6,094
41,974
21,474
3,961
5,467
11,239
57,764
6,832
25,220

77
32
75
132
100
99
60
479
32
133

20
20
10
35
27
24
25
11
22
15

1.2
1.2
1.6
0.6
1.3
1.8
0.6
1.0
1.1
0.7

23.7
24.3
16.2
21.4
34.2
41.9
14.4
11.3
24.1
10.1

19.9
20.3
14.7
15.4
24.6
32.6
11.5
10.4
19.4
8.7

3.1
6.3
4.1
6.9
5.4
7.6
5.3
1.8
3.7
1.8

B*
B
B*
B*
B*
B
B
B*
B*
B

60%
55%
42%
39%
35%
32%
28%
24%
20%
18%

Financials
Industrials
Telecom
IT
Industrials
Health Care
Cons Disc
IT
IT
Cons Disc
Average

HKD 27.4
HKD 47.9
HKD 90.4
HKD 154.3
HKD
6.7
HKD
7.0
USD 16.2
USD 84.0
USD 214.1
HKD 41.1

34,787
7,918
238,757
187,120
2,043
2,999
8,105
195,445
59,123
7,417
46,552

70
14
208
304
13
5
211
1,491
799
13
217

13
13
4
26
27
19
35
23
32
13
21

0.7
0.8
1.9
1.5
1.3
1.2
0.8
1.4
1.3
1.5
1.2

8.7
10.9
13.0
38.8
36.2
23.5
29.3
32.8
42.3
19.7
23.8

7.7
9.3
12.5
30.1
27.1
19.6
21.9
26.9
33.1
17.4
19.2

1.3
1.0
1.6
10.9
2.6
3.4
13.7
6.6
7.5
3.6
4.9

B
B*
B*
B*
B
B*
B
B
B
B

37%
34%
32%
31%
26%
26%
23%
21%
16%
11%
31%

Note: B=Buy, * Denotes stocks on the Conviction List; Pricing as of Dec 1.

Source: FactSet, Bloomberg, I/B/E/S, Goldman Sachs Global Investment Research.

2015 12 3

Executive summary: A nuanced story; alpha markets

2015 in review: A volatile year, full of surprises
In November 2014, we titled our 2015 Outlook report Fat but less flat, embodying our view
that Chinese equities could have a better year in 2015 in absolute returns (less flat vs. 5% in
2014), but were still subject to high return volatility (fat). It turned out that markets have had a
roller-coaster year so far in 2015 (43%/35% peak-to-trough range for A/H), and A shares are up
2% while China H is down 8% ytd.
Besides volatility, another prominent feature for 2015 has been the abundance of surprises:
the 50%+ liquidity-driven (margin financing) rally in A shares in 1H15, the resulting spillover to HK
in April/May, and the deep corrections in both A and H shares during the summer on the liquidity
squeeze. These were followed by forceful policy interventions domestically, followed by the
globally impactful Rmb devaluation in August, a +12% recovery in A shares in 4Q, and finally, the
55%/80% ytd rally for SZCOMP/ChiNext and the 3pp ytd outperformance by MSCI China vs. its
regional peers despite widespread concerns about Chinas macro health.

2016 macro views: A more complicated top-down story

For 2015, we argued that easy liquidity and reforms could re-rate Chinese stocks even in a
slowing growth environment. This year, we think the bar for making the same case has gone
higher as the macro story appears more nuanced. Specifically:

Chinas GDP growth may further slow in 2016 (GS forecast: 6.4% vs. 6.9% in 2015, the
lowest since 1989) as China is undertaking reforms to correct deep-rooted macro imbalances
and to nurture new growth driversharmonizing a New Normal growth profile. A
slowing (trend) growth path isnt surprising but the skepticism around the true growth
state of China, and the associated leverage/bad debt concerns, will remain elevated as our
alternative growth measure suggests that Chinas growth may be 1-2pp weaker than official
GDP statistics may indicate.

Externally, growth delta may slightly improve (GS forecast: 3.5% GDP growth vs. 3.1%
th

in 2015, 5 consecutive year of below 4% growth) but the overall organic growth momentum
remains sluggish. Furthermore, the US rate and political cycles, and the continuing
geopolitical tensions globally and their intertwined linkages with commodity prices, are
dynamic risks which are difficult to price. Overall, we envision an active event calendar,
globally and domestically, in 2016.

Domestic policy/liquidity is likely to stay easy to support growth and to facilitate

reformswe expect monetary and fiscal policies to further loosen. That said, one new risk
factor that has been added to the macro/policy equation is FX. We forecast the Rmb
to moderately weaken against a strong USD (3% in 2016), but the variances around our
baseline view are admittedly high, with non-trivial risks of a meaningful one-off Rmb
devaluation. This is a key risk highlighted by our macro colleagues globally given its
consequential nature to global asset prices.

Reform should remain a topical issue in China as 2016 is the maiden year of the 13th
FYP, which carries significant economic and strategic importance. While we may see
acceleration of reform implementation in areas including SOE and capital markets, we also
expect more corporate (SOE) defaults (by itself a reform to reduce moral hazard) to
surface, which could sporadically provoke systemic concerns and market volatility.

That said, we believe a hard landing scenario remains a low probability event.
We believe China is well equipped to fend off systemic risks given its unique institutional
setup (strong state control), underappreciated balance sheets (high debt but also significant
assets), policy flexibility, and potential reform dividends if the right policies are in place. At the
risk of oversimplifying, we call the macro/policy dynamic an interplay between reform and

2015 12 3

forbearance, meaning that the policy pendulum will continue to swing between pursuing
structural reforms and supporting growth along a bumpy decelerating growth trajectory.

Not all things are flat and uncertain. A new normal growth era is ushering in new waves of
demand and creating a New China group in the equity universe which represents the
secular growth propellants in China for years to come.

2016 market calls: Lowering China to start 2016; focusing on alpha

1.

We believe equity market volatility will likely stay high in a reform vs forbearance setup,
thereby suppressing the markets Sharpe ratios.

2.

Earnings outlook could stay subdued as we forecast mid-single-digit EPS growth for H
and A shares in 2016, and a similar profile for 2017. We are below consensus for both
markets, implying robust organic growth should remain a scarcity.

3.

Valuations appear fair benchmarking against our macro forecasts, with both MXCN and
CSI300 trading at mid-cycle valuations. Liquidity conditions should stay conducive to asset
prices (rate cuts, asset reallocation flows, and index inclusion flows), but we see limited room
for a sustainable re-rating at the index level unless concerns about structural imbalances
recede, most likely triggered by more forceful reform execution.

4.

A more balanced growth/valuation tradeoff leads us to conclude that China no longer stands
favorably compared with its regional peers, especially in 1Q where we expect a meaningful
macro sequential slowdown and A-share liquidity headwinds. As such, we lower China to
Marketweight from Overweight and forecast 7% price return for MXCN in 2016,
largely on earnings accruals. We added China to Overweight on Nov 21, 2013. MXCN has
dropped 5% since then, but outperformed APJ/EM by 6pp/13pp in US$.

5.

1Q is typically a strong quarter for A shares, but we foresee two liquidity risks in 1Q16
resumption of IPOs and expiry of the selling ban from major shareholders. But the more
important subject for A shares is how easy liquidity and growth scarcity are being priced.
Dual-listed A shares are trading at 50% premium over H, and high-growth small caps have
rallied 80% ytd and are trading at 45x forward P/E. We forecast CSI300 to reach 4000 (no
change) by end-16, 10% upside from here.

6.

Growth scarcity, risk/reward, and Rmb risks are the key axes in our thematic thinking. We
would build core positions around New China stocks, which managed to grow top/bottom-line by 37%/45% in 1H15. In Old China, select SOE reform beneficiaries and
bottomed out old economy stocks look attractive given where they are traded in terms
of valuations and profitability expectations. To hedge the Rmb deval risks in the equity space,
we like fundamentally sound companies which may benefit when the Rmb weakens,
paired against those which may lose out.

7.

Top- and bottom-3 performing sectors have yield 33% long-short returns in 2015 on
significant rotations, meaning that investors need to embrace a nimble investment approach
to seek alpha. We are Overweight Tech, Telecom, Healthcare, and Property to start
the year, reflecting our New China bias and defensive orientation.

8.

For actionable single-stock ideas, we highlight 20 names (10 each for A and H) which
collectively express our macro, micro, and thematic views in the equity markets. On average,
they trade on 19x forward P/E and offer 21% 2015-2017 EPS CAGR, with 31% implied
upside to our analysts target prices.

These two pages summarize our key macro and market calls for next year, and our supporting
analyses are detailed in the following sections.
GS China Strategy team

2015 12 3

#1: GrowthBumpy deceleration continues in a new normal era

In aggregate, our economists forecast global growth to moderately improve to 3.5% in

2016 from 3.1% this year, with the positive delta mainly coming from the growth recovery
in Russia and Brazil, which are currently in a technical recession. In the G3, we see
marginally better growth numbers from the EU and Japan next year, although US growth
may decelerate from 2.4% this year to 2.3% next. Overall, global growth will likely be
below 4% for the fifth consecutive year in 2016.

Our economists forecast Chinas real GDP to grow 6.4%, vs. 6.9% in 2015. The 50bps
slowdown in headline GDP growth would be the largest reduction since 2012. In Asia/EM,
they believe India (7.9% for FY16) will outgrow China in 2016, the first time since 1990, with
the Philippines not far behind (6.1%).

Indeed, they expect China to go through a bumpy deceleration process over the medium
to long term. Specifically, they project Chinas (potential) GDP growth to further slow to
around 5.8% for the next 5 years, and then to 4.8% in the decade thereafter, after factoring in
the potential productivity gains as a result of structural reforms but also the growth drag from
the significant debt buildup since the GFC.

Another notable feature of our envisaged growth profile is that macro cyclicality will likely
stay high, reflecting the fact that China is still in the process of optimizing conflicting
objectives (reform, rebalancing, reasonable growth) against a backdrop where global
demand is lackluster, and domestic macro imbalances remain significant.

Our intra-year growth expectations suggest that 1Q16 could be a tough quarter in terms of
sequential growth momentum, with qoq annualized GDP potentially growing at 5.8% (vs. 6.9%
in 4Q15), the lowest since 2009, resulting from the growth hit from anticorruption campaigns
on domestic demand during 1Q. The 1.1pp drop in sequential GDP growth in 1Q16 would also
be the largest quarterly deceleration since 2014.

While absolute growth rates could slow along a bumpy downtrend, we think it is important to
recognize that the growth drivers for China will be (have become) different; notably,
we see more contribution from consumption/services and less from investment and exports,
although the composition of the latter two is also changing. In fact, the share of tertiary sector
in GDP has surpassed secondary since 2012, with the gap further widening in recent years.

New growth drivers could potentially lead to higher growth quality than before, given a
more balanced and sustainable growth profile, and less social deadweight losses (e.g.
pollution, corruption) in the long run, in our view.

The ongoing macro rebalancing and widespread skepticism around official GDP statistics
suggest investors should look beyond the surface when formulating macro and market views
on China. Our economists have recently revamped their alterative growth measure on
ChinaCurrent Activity Indicator (CAI)and conclude that: (i) CAI implies weaker
growth than official GDP in recent periods; (ii) CAI can better reflect recent cyclical
fluctuations in the economy than does GDP data; (iii) the economy may be operating at
around 5% (qoq annualized) in October; and (iv) using CAI as our forecast reference, our
economic growth forecast would be around 5% for 2016.

The 5% growth rate is somewhat consistent with what the market is pricing in, because: a)
our regression analysis on a list of cyclical stocks that have historically correlated well with
CAI growth also suggests current market prices are already implying around 5% macro
growth; and b) our implied growth model, which is a variant of DDM, shows that prevailing
equity valuations are discounting around 0%/4% EPS 10-year CAGR cum banks and exbanks in the equity market.

2015 12 3

Exhibit 6: Our economists forecast GDP growth to

decelerate from 6.9% in 2015 to 6.4% in 2016...

6.4

6.3

6.0
3.5

6.1
3.7

2.3
4.0
0.1

2.0
4.1
0.2

1.50
6.60

1.50
6.80

Avg: 10.4
10

Avg: 10.0

Avg: 8.1

Avg10-14: 8.6

Avg: 9.1

15-19E: 5.8

Avg: 7.2

20-24E: 5.1

25-30E: 4.5

2030

2025

2015

2010

2005

2000

1995

1990

1985

1980

0
1975

6.9

Asia ex Japan
6.1
World
3.1
China real GDP growth contribution (PPT)
Gross capital formation
2.6
Consumption
3.8
Net exports
0.5
China's interest and exchange rates
7D repo rate (%)
2.00
USD/CNY
6.41

12

1970

China

China real GDP growth (%, rolling 5y CAGR)

14

1965

GS Real GDP
US
Euro area
Japan

2017
Current
forecast
2.2
1.6
0.7

2020

GS macro forecasts (% yoy)

2015
2016
Current
Current
forecast
forecast
2.4
2.3
1.5
1.7
0.6
1.0

Exhibit 7: ...consistent with their bumpy deceleration

projection

Note: Average numbers indicates 10y real GDP CAGR.

Source: CEIC, Bloomberg, Goldman Sachs Global Investment Research.

Source: CEIC, Goldman Sachs Global Investment Research.

Exhibit 8: Intra-year growth cyclicality could remain high,

leading to potentially high market volatility

Exhibit 9: In a new normal growth era, tertiary sectors

are becoming a more important growth driver than
secondary

(qoq ann %)
GS forecasts

8.3

China GDP
growth [RHS]

7.3
6.9

Dec-14

Dec-13

Dec-12

Dec-11

Dec-10

Dec-09

Dec-08

Dec-07

Dec-06

Dec-05

Dec-04

35%

Dec-16

Jun-16

Dec-15

Jun-15

Dec-14

Jun-14

41%

Dec-03

5.8
Dec-13

43%

6.3

50
Jun-13

45%
40%

6.0
5.8 6.0

Dec-12

51%

Tertiary industry excl. financials

6.8

6.5

55

Tertiary industry
50%

7.8

65
60

Secondary industry

Dec-02

70

Share in overall nominal GDP

55%

Dec-01

MSCI
China

75

8.8

Dec-00

MXCN
80

Source: Bloomberg, Goldman Sachs Global Investment Research.

Source: Wind.

Exhibit 10: Investors may continue to see high

discrepancy between reported growth statistics and our
alternative growth proxy

Exhibit 11: Cyclicals, which are sensitive to China

growth, seem to be already discounting around 5% CAI
growth

GS Current Activity Indicator

10

20

30

10

-10

-20

-30

Dec-15

Jun-15

Dec-14

Jun-14

-40

Dec-13

Jun-13

Dec-12

Jun-12

Dec-11

Jun-11

Dec-10

* based on the returns of a stock basket

with high correlation with China growth (CAI)

Dec-09

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

CAI (actual)

Jun-10

Source: NBS, Goldman Sachs Global Investment Research.

11

qoq (%)
China CAI
CAI
40
Basket avg return
(market implied*)
(Leading 2 mo) [RHS]

qoq ann. (%)

12

Real GDP

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

Jan-07

(%, qoq annualized)

20
18
16
14
12
10
8
6
4
2
0

Source: Goldman Sachs Global Investment Research.

2015 12 3

#2: PolicyPro-growth stance remains

Policy/growth backdrop

Chinas total debt to GDP ratio could reach 237% by the end of 2015, and gradually
rise to 250% over the next 3 years before stabilizing, based on our economists projection.
Their work, which focuses on the dynamics between macro leverage and interest rate policy
of more than 55 countries in the past 50 years, also suggests that significant buildup in

debt (to GDP) has tended to result in a low absolute level of interest rates in
subsequent periods.

Nominal (5.7%) and real (6.3% based on our estimate) funding costs remain high in both
historical and global contexts.

China needs easy policy, monetarily and fiscally, to facilitate the implementation of
structural reforms, which tend to be growth-suppressive in the short term.

Private sector investment has meaningfully slowed in recent years, as evidenced by

the falling property and manufacturing FAI growth amid falling investment returns (i.e. ROIC
and ICOR). Local governments spending is constrained by the anticorruption drive
and fiscal reforms of moving off-budget borrowing to on-budget, especially earlier in the year.

Monetary policy: More easing to come

Our economists expect the PBoC to cut benchmark interest rates twice, most likely in
asymmetric form, and to cut RRR by 300bps to alleviate capital outflows, which could
amount to 2.4% of GDP in 2016 (US$270bn), derived from our economists explicit forecasts
on FX reserves (flat) and current account surplus (2.4%).

They also expect the 7D repo, an important short-term funding cost proxy for banks and the
economy, to go down to 1.5% by end-2016, from around 2.4% at present.

M2, TSF, and new loan growth (target) could be slightly higher than in 2015, while
specific monetary operations with targeted recipients, such as targeted RRR cuts, PSL, and
MLF will likely remain popular policy tools for the PBoC to manage liquidity conditions.

Fiscal policy: Proactive and expansionary

Fiscal policy stance should remain expansionary in 2016on-budget deficit could

increase to 3% of GDP, vs. 2.8% in 2015, while the true deficits, which include local
government borrowings and off-budget land sales, could rise to 10% in 2016 from around
9.6% this year (both based on our economists forecast).

Further expansion of the LGFV debt swap program (now Rmb3.2tn, from Rmb1tn at
the beginning of 2015) is likely given the Rmb3tn of LGFV loans that will be due in 2016 as
estimated by our economists.

Policy banks participation in infrastructure projects could become more

noticeable after the PBoCs capital injection to two policy banks in mid-2015 (~US$100bn of
unlevered capital).

Underneath the broad infra investment category, soft infrastructure (hospitals, schools,
sewage system, and other environmental-related and public goods projects) is showing
moderately higher momentum vs. the traditional hard infrastructure, which typically focuses
on transportation infra investment including highways, bridges, and high-speed railways. We
think this trend is likely to extend as public goods related investment is regarded by
policymakers as one of the key levers to sustain and enhance growth going forward, as
stated in the 13th Five Year Blueprint (FYP). Also see page 31 for details.

2015 12 3

Exhibit 12: High debt buildup, elevated real interest rates

and policymakers commitment to reforms should drive
rates lower
7D repo
10Y govt bond yield

(%)

1Y benchmark lending rate

RRR (major banks) - RHS(%)

7
24

GS
forecast

22

20

3.6

18

16

14.5

14

1.5

Jul-16

M2 at end 2014

(% of GDP)
200%
180%

(US$tn)
20
18

M2 as % of GDP

160%

16

M2 (US tn)

140%

14

120%

12

100%
80%

10

12
10

60%

Oct-16

Apr-16

Jan-16

Jul-15

Oct-15

Apr-15

Jan-15

Jul-14

Oct-14

Apr-14

Jan-14

Jul-13

Oct-13

Apr-13

Jan-13

Jul-12

Oct-12

Apr-12

Jan-12

Exhibit 13: Broad financial conditions remain

accommodative for Chinese assets

40%

6
US

EU

Japan

China

Source: Bloomberg, Goldman Sachs Global Investment Research.

Source: Wind, FactSet, CEIC.

Exhibit 14: True or augmented fiscal deficits should stay

high in 2016

Exhibit 15: The size of the LGFV debt swap program has
expanded significantly since 2Q15

2013

2014 2015E 2016E

Source: PBoC, CEIC, Wind, Goldman Sachs Global Investment Research.

Source: Wind.

Exhibit 16: Government spending on healthcare and

public goods services has shown strong momentum

Exhibit 17: Infra spending has held up well despite the

weakening trends in property and manufacturing FAI

Government expenditure (tn RMB, as of 2014)

2.5

2014

2.0

2013-14 growth - RHS

1.5
1.0
0.5
0.0

Growth (%)

25%
20%
15%
Total growth: 8%
10%
5%
0%
-5%

Oct-15

2012

Jul-15

2011

Apr-15

2010

Oct-14

-25
2009

Jan-15

-25

Jul-14

-20

Overall augmented fiscal deficit

Apr-14

Offbudget from borrowing

-20

Oct-13

-15

On budget

Jan-14

Offbudget from land sales net proceeds

-15

Jul-13

-10

Apr-13

-10

Oct-12

-5

Jan-13

-5

(bn RMB)
800
Local government bond (swap+new issurance, net)
700
LGFV
600
500
400
300
200
100
0
-100

Jul-12

Apr-12

Share of GDP (%)

Jan-12

Share of GDP (%)

China FAI yoy growth (%, 3m rolling avg)

Manufacturing+Property

50

Infra (Transportation)
40

Infra (Water/Edu/Health/Sports)

30
20
10
0

Aug-15

Apr-15

Dec-14

Apr-14

Aug-14

Dec-13

Apr-13

Aug-13

Dec-12

Aug-12

Apr-12

Dec-11

Aug-11

Apr-11

Dec-10

Aug-10

Apr-10

-10

Note: both central and local government expenditures are included.

Source: Wind.

Source: CEIC.

2015 12 3

#3: RmbModerately weaker vs. the USD; hedging the tail risks

Our economists call for the Rmb to moderately weaken against the USD to 6.6 by end16, and 6.8 by end 17, implying 3%/6% nominal depreciation over the next 12/24 months.
The relative weakness of the Rmb vs. the USD is primarily a function of our bullish USD
forecasts, which point to 10% and 6% vs. the EUD and JPY in 2016. As such, they expect
the Rmb to remain firm on a trade-weighted basis.

As our economists have noted, their central case for Rmb exchange rates is subject to high
variances given the uncertainty revolving around (or the difficulty to forecast): (i) the relative
growth momentum and interest rate differentials between the US and China; (ii) the dynamic
of capital flows and the porosity of the capital account; and (iii) (market perception on) policy
efficacy and creditability of Chinese policymakers.

Specifically, they believe the outcome distribution of their forecasts could follow a tri-modal

process, whereby the PBoC may:

Keep the Rmb stable against the USD, effectively maintaining the quasi-dollar
peg and strengthening the Rmb on a trade-weighted basis.

Allow the Rmb to moderately and gradually depreciate vs. the USD in order
to keep the currency at stable trade-weighted exchange rates.

A one-off depreciation, probably in a meaningful magnitude (5% to 10%), to help

the currency regain its competitiveness.

These options have their pros and cons: Defending the currency vs. a strong USD
could boost market confidence, but runs the risk of draining FX reserves, which have
dropped 11% from the peak of US$4tn in June 2014. Opting for an orderly depreciation fits
the policy objective of introducing market forces to the FX pricing mechanism but could
intensify the expectation of a more significant depreciation down the road, thereby creating a
negative, self-reinforcing spiral. A one-off adjustment could quickly realign FX valuation with
fundamentals but could lead to excessive volatility in global markets, as evidenced in the
most recent episode (August 11) where the Rmb devaluation (reform) caused significant
shocks to asset classes globally. This is also consistent with our regional analysis, which
shows that the China-linked economies in the region, such as HK, Korea, and Taiwan, could
be negatively impacted by an abrupt Rmb devaluation. Overall, we believe PBoCs policy
choices are bounded by an impossible trinity dilemma, as flagged by our economists.
See Asia Economics Analyst: China: Diving deeper into the "impossible trinity", Sep 29.

In our piece: China Strategy: RMB depreciation: Mixed impact on Chinese equities, focus on
potential FX winners and losers, Aug 12, we laid out three key channels through which
FX could influence equity returns: 1) translation exposure; 2) transaction/economic
exposure; and 3) equity risk premium (ERP). In our FX base case, we see a moderate 3%
depreciation p.a. having only modest impact on ERP, meaning that the ramifications will
likely manifest primarily in the stock markets through the translation and
transaction/economic channels.

However, if a one-off adjustment were to materialize, the market reaction function could
be more forceful and dynamic. For reference, the last major, one-off RMB devaluation
episode was in 1994, when the currency was rebased from 5.8 to 8.7 vs. the USD on Jan 1,
1994 as the PBOC unified the dual-tracked official and swap center rates. Onshore and
offshore equities performed poorly after the devaluation, losing 10% to 20% 1 to 3
months after the event.

In any case, as featured in many of our economic and strategy outlook pieces globally, a
strong rally in USDCNY/H is a key risk to global asset prices in 2016 through the FX,
flows, sentiment, economic, and even political channels; hence, proactively hedging and

2015 12 3

trading this risk factor forms one of the key axes in our thematic thinking and implementation
strategy for 2016. See page 37 for more detailed discussion.
Exhibit 18: Rmb may weaken against a strong USD, but
should remain firm vis-a-vis other major currencies
CNY fixing (vs. USD)

GS Traded-Weighted Index
(index 2000 = 100)
CNY fixing
160
GS Trade-Weighted Index 17E: 6.8 (NDF: 6.8)
150

130

-50

120

-100

110

-150

3.2

100

-200

3.0

3.6

Oct-15

Aug-15

Apr-15

Jun-15

Feb-15

Oct-14

Dec-14

Aug-14

Apr-14

Jun-14

Feb-14

Oct-13

Dec-13

3.4

Aug-13

Dec-17

Dec-16

Dec-15

Dec-14

Dec-13

Dec-12

Dec-11

Dec-10

Dec-09

6.0

3.8

Apr-13

15E: 6.4

6.2

4.0

Jun-13

6.4

4.2

140

Feb-13

16E: 6.6
(NDF: 6.6)

(US$ tn)

50

Oct-12

6.6

100

Dec-12

6.8

China's FX reserves - RHS

Decrease in PBOC's foreign asset
FX purchases
FX flow proxy (based on SAFE data)

(US$ bn)
150

Aug-12

7.0

Exhibit 19: Capital outflow remains a key macro risk...

Note: 12m and 24m CNY NDFs are as of Nov 24, 2015.
Source: Bloomberg, Goldman Sachs Global Investment Research.

Source: PBoC, SAFE, Goldman Sachs Global Investment Research.

Exhibit 20: ...not only for China itself, but also for other
global asset markets

Exhibit 21: China-linked economies in the region could be

negatively impacted if the Rmb meaningfully weakens

Return form Aug 11 to Sep 30 (%)

5
Equity
0
-5

Sensitivity of equity returns to depreciation of the Rmb

0.5

Bond

0
-0.5

-10
-15

-1

Commodity

-20
-25

Japan 10Y

Germany 10Y

UK 10Y

US 10Y

Iron Ore

LME Copper

Brent

CMX Gold

MSCI EM

Nikkei 225

Euro STOXX 50

S&P 500

NASDAQ

CSI 300

MSCI AC World

MSCI China

-1.5
-2
-2.5
-3
CN

HK

TH

TW

MY

KR

SG

IN

ID

PH

Note: Equity returns are calculated with indices in USD.

Note: Calculated using our 4-factor regression model. See Asia Pacific Strategy:
2016 Outlook: Muted returns, targeted opportunities, (Dec 4) for details.

Source: Bloomberg.

Source: FactSet, MSCI, Haver, Goldman Sachs Global Investment Research.

Exhibit 22: FX impacts (economic exposure) on earnings

seem moderate, based on our analysts bottom-up
estimates

Exhibit 23: History suggests an abrupt depreciation could

provoke forceful market reaction function investors
should proactively manage this tail-probability event

% earnings change per 1% RMB

depreciation vs. USD

% earnings change per

1% RMB depreciation

0.0%

Equalweighted

Market capweighted

Financials

0.1%

0.2%

Info Tech

0.1%

0.1%

Telecos

0.0%

0.0%

Health Care

0.0%

0.0%

Energy

1.1%

-0.1%

Cons Disc

-0.4%

-0.1%

Cons Stap

-0.2%

-0.3%

Materials

0.1%

-0.4%

Utilities

-0.7%

-1.0%

Industrials

-1.5%

-1.4%

-0.1%
-0.2%

-0.18%

-0.3%
-0.4%
-0.5%

-0.45%
Equal-weighted

Market capweighted

Source: Goldman Sachs Global Investment Research.

Performance since Dec 31, 1993 close

Offshore
Onshore

Global

1D

1W

1M

3M

6M

MXCN

-1%

-3%

-10%

-23%

-10%

HSCEI

0%

-5%

-10%

-22%

-22%

SHCOMP

0%

5%

-12%

-9%

-33%

SZCOMP

-2%

4%

-17%

-11%

-33%

MXAPJ

1%

-5%

0%

-14%

3%

MXEM

0%

2%

6%

0%

11%

MXWD

0%

1%

5%

-6%

2%

Source: MSCI, Bloomberg, FactSet.

10

2015 12 3

#4: ReformsMany stories; varied paces

What and how much has been done? This is always a contentious topic given the broad
rd
array of new initiatives laid out in the ambitious reform blueprint during the 3 Party Plenum
in Nov 2013, and the very diverse starting expectations among investors. Comparing the key
stated policy goals in the blueprint and some observable developments over the past 2 years,
we would argue that China has made significant strides in, for example, interest rate
liberalization, anticorruption, and a few social welfare-related areas. However, the
progress of difficult reforms including SOE, capital markets, and fiscal reforms looks
somewhat slower than what policymakers have been guiding, in our view.

What to expect from here? Our conversations with investors globally suggest market
expectations on difficult structural reforms are low (and rightly so), but on the flipside, this
implies that positive surprises will most likely come from these areas, especially with the
rd
anticorruption campaign going into its 3 year, which may result in better policy coordination
and incentive alignment between central and local governments. We highlight our reform
expectations as follows:

SOE

The second round of central-government-owned SOE reform may kick off in 2016
although the execution of the first batch (announced in July 2014) has been slow. We expect
relatively more corporate actions to take place at the local SOE level, extending the
momentum in 2015, where more than 76 corporate restructuring cases have been
announced.

In 2015, we observe at least 2 cases where SOEs have defaulted on their bonds, all in the
onshore market (there have been more defaults on bank loans, but these are difficult to
track). Our credit strategists expect more SOE defaults next year, especially in the
challenging commodity-related and industrial sectors. While SOE defaults arent currently
dealt with in a systematic approach (they are often subject to significant negotiation between
the SOEs, governments, and creditors), we believe allowing more SOEs to go under is
important to correct the moral hazard, and hence the capital misallocation, in the system.

Financial markets

The excessive volatility in the A-share markets has delayed a number of key financial
markets reforms, including the IPO registration system and the announcement and
implementation of the SZ-HK Connect, but we expect these will get back on track in 2016
as market volatility subsides.

In terms of regulatory changes, we may see organizational restructuring among key

regulatory bodies (PBoC, CSRC, CBRC, CIRC) as mentioned by President Xi in the official
th
5 Plenum document.

Three new free-trade-zones (FTZ) were set up in 2015, in addition to Shanghai, which
launched in 2013. We expect further development in terms of capital account convertibility
and reduction of the negative lists in these FTZs.

Fiscal
LGFV debt swaps remain a major policy tool to improve transparency and accountability of

local government finances. We expect the total amount of LGFV debt swaps to reach
Rmb3.2tn in 2015, and expand to around Rmb6.2tn in 2016. However, there has been little
progress so far regarding the compilation of local governments balance sheets, and/or the
division of responsibility and spending rights between the central and local governments.

Some progress has been made on Business Tax (BT) and Value-Added Tax (VAT)
reform, but changing the tax regime in industries like construction, real estate, and financial
services has been difficult due to the uncertainty in deductible items, high cost of tax

11

2015 12 3

collection, and tax revenue sharing negotiations between the central and local governments.
We may see a further push on this front in 2016.

We also expect more tax reforms focusing on tax equalization (e.g. raising taxes for
product oil, tobacco, and spirits/wine but lowering taxes for discretionary and/or luxury items
such as cosmetics and jewelry) and using taxes to improve resources allocation (e.g.
changing resource tax on rare earth, tungsten and molybdenum from volume-based to valuebased). There could be further revamp of the personal income tax regime aiming to enhance
income accounting, in our view.

Social/welfare

The full abolishment of the one-child policy will likely be enacted post the National
Peoples Congress (NPC). We believe this could be followed by drug pricing reform, further
hospital industry liberalization, and promotion of mobile healthcare services.

More deregulation and promotion on education, cultural, and entertainment industry is

likely, but with an emphasis on internet and technology overlay/application.

Hukou reform progress has been trailing market expectations, but some lower-tier cities
have relaxed Hukou restrictions and launched residence permit schemes (similar to the
Hukou system but is linked to the residents employment). In contrast, tier-1 cities like Beijing
and Shanghai have tightened Hukou policies given strong population inflows.

We also expect further development on social security coverage for urban and rural
residents, with a focus on aligning social security systems between urban and rural
households, and achieving cross-region mobility and full-healthcare insurance coverage
(regardless of Hukou).

Environmental protection and new energy

Despite falling energy intensity in the past years (partly contributed by falling commodity
prices), Chinas pollution conditions have deteriorated in some areas: air quality in
Northeast China, water contamination across the country, and land pollution (land
degradation, reduction of arable land) in some mining-oriented regions have worsened. We
expect more production capability shutdowns in polluted and energy-intensive industries
although the commitment levels could inversely correlate with the economic growth
momentum, in our view.
We expect the more supportive measures to facilitate the development of solar, wind, and

nuclear energy, and new energy vehicles, as stated in the 13th FYP.

Deregulation/anticorruption

In its 2015 working report, the government mentioned that 246 administrative approval
procedures were removed in the past year, and the number of newly registered companies
has grown by 46%. Cutting red tape is probably one of the key levers for China to increase
its macro efficiency and we expect the strong momentum to continue, consistent with the
negative list approach.

The government has stepped up its anticorruption campaign since the 18 CPC National
Congress, resulting in investigations of more than 100 officials at or above provincial and
ministerial level. The intensity of the campaign is likely to stay high as the Commission
for Discipline Inspection has recently sent delegates to almost all provinces and central
SOEs, and announced a new set of CPC intraparty supervisory disciplinary regulations to
govern the conduct of government officials and CPC members, although some sectors have
already seen more charges than others.

th

12

2015 12 3

rd

Exhibit 24: Since the 3 Plenum, more progress has been made on social reforms, anticorruption, and select financial
market reforms, while the development of SOE reform has lagged behind, in our view
Key reforms from 18th CPC Third Plenum decision document
SOE reform
Mixed ownership reform: introduce private capital into SOEs'
operation
State-owned assets mgmt: establish various state owned assets
mgmt companies
Management incentive reform: salary cuts on management;
employee Stock Ownership Plan

*
*
*

Corporate governance focus, enhance transparency/disclosure and

market based operation
Create fair environment for private capital and allow to non-SOEs
enter authorized business area

GS comments

Progress

CNR and CSR merged, but no salient efficiency improving actions are observed, i.e. layoffs.
Progress of mixed ownership reforms on pilot central SOEs is slow (below expectation).
Reforms on SDIC and COFCO, as the pilot state-owned assets mgmt companies are slow, with only
small-scale restructuring.
Compensation of senior managers has been limited. Several SOEs launched the Employee Stock
Ownership Plans.
Slow progress

Lower entry barrier/establish negative list for investment.

Simplify business registration procedures

Private capital has been allowed to enter the retail business of Sinopec, but subsequent progress
has been slow.
Slow progress

Financial/Fiscal reform
Speed up interest rate deregulation/Deposit insurance
Market-pricing of CNY / treasury yield
Speed up capital account convertibility
Registration system for IPO
Budget system reform: more longer term, more accountability and
transparency
Tax: simplify VAT; consumption tax reform; property tax, resource
taxes, environmental protection taxes

****
**
**
*
*
**

Progressing rapidly. The control of deposit and lending rates will be gradually relaxed.
SDR inclusion; fluctuation range of RMB were expanded; China's interest rate corridor framework
More progress in SH FTZ; Currency swap
Slightly below expectation; may launch in Mar 2016;
Enhancing supervision on local government debt. LGFV debt swaps alleviate burden for local
governments.
Progress to replace business taxes with value-added taxed is below expectation, especially for
financial industries, etc. Progressing on resource tax and consumption tax reforms; progressing
slowly on property tax reform.

Expenditure allocation between central/local gov'ts: fiscal

transfer reforms

Slow progress

Establish government balance sheets at national and local

levels

Slow progress

Safety welfare, New Urbanization

One child policy: Two children will be allowed for a couple

*****

Abolishment of one-child policy is in line with expectation, and will implement in 2016.

Rural Land reform: Unify urban/rural construction land market

Slow progress

More protection to farmers: encourage investment projects in rural

areas

Slow progress

Hukou reform: fully open hukou in smaller cities, gradually open

hukou in mid sized cities

Some regions gradually replace Hukou with resident permits, however, Tier 1 cities, such as Beijing,
Shanghai, have stricter household registration policies.

**
**

95% of population is now covered by social insurance, and expected to expand. Investment range of
pension funds will be expanded.

**

Slow progress
Price control is relaxed for some medicines. Fiscal expenditure on public hospital has increased.
More progress is needed for the development of private hospital, mobile hospital, and reform on
subsidiary system of public hospitals.

Market pricing reform in water / oil / gas / power / transport /

telecom

**

Reform on the resource price has achieved some progress (more market-oriented), and may
accelerate in 2016.

Support FTZ development

**

Shanghai FTA: development on tariff policies, administrative convenience, and potential open-up of
capital accounts (i.e. investment overseas); 3 new FTAs are set up in Tianjin, Fujian and Guangdong.

Liberalize foreign investment access

In the new Catalogue for the Guidance of Foreign Investment, industrial sectors restricted to foreign
investors have been reduced from 79 to 38, a negative list approach has been adopted, and foreign
ownership limitations are further relaxed.

**

Mentioned in the 2015 government work report, 246 administrative approval items were removed in
the past year, and the number of newly registered companies has grown by 45.9%.

***

A new version of the CPC intraparty supervisory disciplinary regulations to restrict the conduct of
government officials has been announced. The government has stepped up its anti-corruption
campaign, resulting in investigations on c. 100 officials at or above provincial and ministerial level.

The State Council has organized several supervisory trips to instruct local governments to maintain
economic growth, but an evaluation system on local governments have not been established.

Pension reform: Expand social insurance coverage, lower fee rates

Establish individual income/asset ownership data system
Health care reform: medical insurance, service, pharm chains and
supervision;

Market economy/deregulation

Anti-corruption/deregulation
Streamline administrative processes: withdraw administrative
approvals, tackle overcapacity
Develop supervision system of the Party
Revise econ KPI for gov't officials: include environment / debt /
overcapacity / innovation etc.

Environmental protection & culture reform

Environmental prevention plans on air, water and soil pollution
Strengthen control of energy consumption of energy intensive
industries
Promotion plans of new energy
Culture reform: consolidate media resources; encourage mergers
and acquisitions
Note:

*
**
**
*

Chinas pollution has probably deteriorated, incl. air pollution in North China, water pollution
nationwide, and land contamination in some mining areas.
Some high-pollution and energy-intensive companies have been shut down in some areas, i.e.
North China, but progress is slow with pressure to maintain economic growth.
Policies to encourage development of solar power, wind power and nuclear power have been
issued. Development of new energy vehicles is promoted.
Without major reforms on culture, some changes have been initiated with a bottom-up approach,
i.e. mergers of media companies, import of movies, etc.

* Red starts indicate the progress estimated. 0 - almost no progress, 5 - almost achieved, and the rest follow the order.

Source: Xinhua News, Goldman Sachs Global Investment Research.

13

2015 12 3

Exhibit 25: Our bottom-up analysis suggests implied

NPLs for banks could be as high as 10% in China

Exhibit 26: More defaults have surfaced, including those

from SOEs
Default
Year

Implied NPL ratio (EBITDA < int exp)

14%
12.5%
12%
10.4%
10%
8.3%
8%
6.5%
6%
5.8%
5.2%
4%

9.8%

8.8%
7.7%
5.7%

9M2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2014
2014
2014
2015
2015
2015
2015
2015

Source: Wind, Gao Hua Securities Research.

2014
2015
2015
2015
2015
2015

Default
Amount

(US$ mn)

China Forestry Holdings Co

LDK Solar Co
Hidili Industry International Development Ltd
Kaisa Group Holdings Ltd
Renhe Commercial
Winsway Enterprises
Hidili Industry Intl Development
China Fishery Group

300
183
400
1050
900
500
400
288

Onshore defaults

0%

2004

SOE
(Y/N)

Offshore defaults

11.7%

2.4%

2%

Issuer Name

Shanghai Chaori Solar

Cloud Live Technology
Baoding Tianwei
Zhuhai Zhongfu
Baoding Tianwei Yingli New Energy Resources
Sinosteel

(Rmb mn)

1000
480
1500
590
1000
2000

Source: Wind, Goldman Sachs Global Investment Research.

Exhibit 27: Our reform expectations for 2016

Key reform expectations in 2016

SOE

Financial markets

Fiscal

Social/welfare

Environmental
protection and new
energy
Deregulation/
anticorruption

Second round of central SOE reforms

More developments on local SOE reforms
More SOE defaults to reduce the moral hazard

IPO reform toward a registration-based system

SZ-HK Stock Connect
Potential reorganization among regulators (PBoC, CSRC,
CBRC and CIRC)
Capital account opening and negative list reduction in FTZs
Expansion of the LGFV debt swap program
Further push on Business Tax and Value-Added Tax reform
Other tax reforms (natural resources, personal income, etc)
Enact the abolishment of the one-child policy post the NPC

More deregulation on education and entertainment industries

Enhance social security coverage
More production capacity shutdowns in polluted industries
Supportive measures on renewable energy industries (solar,
wind, nuclear)
Cutting administrative red tapes
Intensity of anticorruption to stay high

Source: Goldman Sachs Global Investment Research.

14

2015 12 3

#5: PropertyA tale of 2 stories; FAI to modestly recover

The Chinese property market is always in the spotlight, not because of its weight in the equity
market (5%/9% in A/H), but its importance to economic growth in China. Our economists
estimate that the property sector and its related value-chain demand have on average
contributed 1pp of GDP growth for the past 3 years.

From a top-down perspective, we believe analyzing the China property market as a

homogenous asset class could be misleadingover the past 3 years, property prices for

tier 1 cities have risen 67%, while the prices for tier 2 and tier 3 are essentially flat.
In our view, the divergent property prices are attributable to the favorable supply/demand
balance in higher-tier cities, as evidenced by the faster inventory destocking cycle there.

While tier 1 cities are more economically important (12% of GDP), lower tiered cities carry
higher weight in terms of growth contribution as they in aggregate represent 89% of
the total property FAI in the past 5 years.

In 2016, our economists and property research team expect a moderate pickup in
property-related investment as well as further stabilization in property sales (GS
forecast 6% yoy growth in 2016 vs. 15% in 2015 ytd) for the following reasons:

Funding difficulties faced by property developers have eased following official

permission for them to gain wider access to bond financing. So far in 2015,
developers have raised close to Rmb400bn in bond proceeds (a 7x increase from
the total issuance in 2014), often at yields lower than in the offshore market;

Land transactions, which have historically led FAI by 6 months, have begun to
increase; and

On the demand side, our envisaged (further) monetary easing and potentially
more relaxation of housing restrictions (e.g. lower down-payment) should buttress
st
the robust underlying housing demand (1 time homebuyer), which roughly
accounts for around 70% of the transactions over the past few years.

While we forecast a rebound in real estate activities in 2016, we dont think it will translate
into a sustainable resurgence of commodity demand, particularly the capex commodities,
as: a) we forecast manufacturing FAI, which represents around 40% of total FAI, to further
slow in 2016 given the weak exports, overcapacity, and a strong deflationary trend and, b) as
China gets richer, the demand for capex commodities should naturally drop, while opex
demand growth only begins to peak at higher income levels.

One of the prevalent concerns from investors on Chinas macro sustainability is that property
inventory data (based on select cities where quality of statistics is more reliable) doesnt show a
complete picture of the nationwide housing market, and that there are many ghost cities in
China which pose systemic risk to the banking system. We fully acknowledge these risks but
think the concern is somewhat overstated because:
1.

Based on the compilation by China Investment Network, a private business

newspaper, the top 34 cities with the highest supply/demand imbalances
(population/constructed areas <0.5) in total represented 7.3% of Chinas 2013
GDP and 5.6% of Chinas total population, equivalent to 76mn. We expect those
ratios are lower now.

2.

While some of these ghost cities will likely remain haunted in the foreseeable
future because of continued negative population flows, we believe their systemic
implications should be contained given the lower nominal property values in
these less developed areas vs. higher tier cities.

15

2015 12 3

Exhibit 28: Tier 1 cities have outperformed lower tier cites

in terms of property prices since the GFC
(Rmb/sqm)
25,000

Tier 1 cities ASP

+167%

Tier 2 cities ASP

Tier 3 cities ASP

20,000

Exhibit 29: The inventory adjustment cycle is also more

mature for tier 1 cities than the lower tier cities
(Inventory months)

Tier 1 cities

25

Select tier 2 cities

Select tier 3 cities

20
15

15,000
10

+105%
+72%

10,000

Note: 1. Inventory months are calculated as sellable GFA divided by 12-m rolling GFA
sold. 2.Tier 1 cities include Beijing, Shanghai, Shenzhen and Guangzhou. Selective tier 2
cities include Nanjing, Suzhou, Hangzhou, Xiamen, Qingdao. Selective tier 3 cities
include Dongguan, Hefei, Wenzhou, Ningbo, Bengbu, Fuzhou and Huizhou.

Source: CREIS

Exhibit 30: We forecast property FAI to recover in 2016,

on the back of improving land sales in recent months

Exhibit 31: But the overarching capex to opex demand

shift remains intact as the macro rebalancing unfolds

Property FAI

Land transactions (lead 6M, RHS)

35

200
150

25

100
15

50

-5

Jan-16

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

-50

Kerosene
Gasoline
Zinc***
Soybean*
Aluminium
Oil (total)
Coffee*
Nickel**
Corn*
Naptha
Diesel
Sugar*
Copper
Cotton*
Wheat*
Iron Ore
Cement
Met Coal
Thermal Coal
Steel

CapEx
commodities

(%yoy, 3mma)
250

OpEx
commoditie

Source: CREIS, Gao Hua Securities Research.

(%yoy, 3mma)
45

Sep-15

Jan-15

May-15

Sep-14

May-14

Jan-14

Sep-13

Jan-13

May-13

Sep-12

Jan-12

May-12

Sep-11

Jan-11

May-11

Sep-10

Jan-10

Jan-13
Jun-13
Nov-13
Apr-14
Sep-14
Feb-15
Jul-15

Dec-10
May-11
Oct-11
Mar-12
Aug-12

Jan-08
Jun-08
Nov-08
Apr-09
Sep-09
Feb-10
Jul-10

Note: Tier 1 cities include Beijing, Shanghai, Shenzhen and Guangzhou. Tier 2 cities
include Tianjin, Nanjing, Chengdu, Changsha, Sanya, Suzhou, Qingdao, Xiamen, Dalian,
Chongqing, and Xi'an. Tier 3 cities include Fuzhou, Nanchang, Dongguan, Huizhou,
Wenzhou, Baotou, Ningbo, Shantou and Bengbu.

May-10

5,000

China consumption growth

2015 ytd (% yoy)

-10
-5
0
5
10
15
20
*Est. 2015 annual consumption growth (no monthly data) ; **calculated from apparent Stainless
Steel demand; ***calculated from zinc galv. production

Source: Bloomberg, CEIC.

Source: IEA, WoodMackenzie, CRU, USDA, Goldman Sachs Global Investment

Research.

Exhibit 32: There could be a number of ghost cities in

China, but their aggregate economic weight is not as
daunting as their vacant apartments may suggest

Exhibit 33: Chronic over-supply is unlikely to improve for

some less-developed provinces in the near future given
population outflows

Erenhot
Qinzhou
lhasa
Jiayuguan
Jinggangshan
Weihai
Xilinhot
Jiaxing
Shizuishan
Sanya
Jinchang
Huizhou
Yicheng
Wuzhong
Changshu
Yiwu
Chuzhou

Total

Ghost
city
index

2013 GDP
(bn RMB)

0.07
0.26
0.28
0.32
0.33
0.36
0.37
0.39
0.40
0.40
0.41
0.42
0.42
0.42
0.42
0.43
0.44

8
75
8
23
5
255
21
315
45
37
25
268
23
35
198
88
109

As % of
China total
GDP
0.0%
0.1%
0.0%
0.0%
0.0%
0.4%
0.0%
0.5%
0.1%
0.1%
0.0%
0.5%
0.0%
0.1%
0.3%
0.2%
0.2%
2.6%

No. 18-34
Fangchenggang
Chengde
Zhongshan
Quzhou
Lishui
YiChun
Shaoxing
Daqing
Maoming
Zhoukou
Kelamayi
Xianning
Ordos
Zhaoqing
Jiuquan
Guyuan
Zhangye

Ghost
city
index

2013 GDP
(bn RMB)

0.44
0.45
0.45
0.45
0.45
0.46
0.46
0.47
0.47
0.47
0.47
0.48
0.49
0.49
0.49
0.49
0.49

53
127
264
106
98
28
397
418
216
179
85
87
396
166
64
18
34

As % of
China total
GDP
0.1%
0.2%
0.4%
0.2%
0.2%
0.0%
0.7%
0.7%
0.4%
0.3%
0.1%
0.1%
0.7%
0.3%
0.1%
0.0%
0.1%
4.7%

Note: Ghost cities are defined as cities with the ratio of the current population divided
by the potential population supported by finished construction below 0.5. According to
the Ministry of Housing standard, each developed square kilometer can accommodate
10,000 residents. The list is created by China Investment Network, a business
newspaper.

Source: Wind.

Property FAI CAGR - Population CAGR (2004-14)

40%

(Rmb k)

GDP per capita - national avg (2014, Rmb k, RHS)

110

35%

100

30%

90
80

25%

70
20%
60
15%

50

10%

40

5%

30

0%

20

Hainan
Guizhou
Shaanxi
Shanxi
Xinjiang
Yunnan
Qinghai
Tibet
Anhui
Sichuan
Henan
Hubei
Gansu
Inner Mongolia
Ningxia
Fujian
Hebei
Guangxi
Chongqing
Hunan
Liaoning
Shandong
Jilin
Jiangsu
Jiangxi
Tianjin
Heilongjiang
Zhejiang
Guangdong
Beijing
Shanghai

No. 1-17

Source: Wind.

16

2015 12 3

#6: MarketsLowering China to MW to start 2016, alpha over beta

Aggregating our macro expectations, earnings forecasts, equity valuation assessments, and
views on event/ liquidity risks, we conclude that the risk/reward for Chinese equities no
longer stands favorably relative to their regional alternatives.

Furthermore, we see a couple of cyclical macro and liquidity headwinds in 1Q16 which
may go against market performance, notably a seasonal growth deceleration driven by policy
and anticorruption, A-share IPO resumption, and expiry of selling restrictions for major
shareholders in A shares. See pages 27-28 for more discussion about liquidity risks.

As such, we moderate our Overweight stance on offshore China to Marketweight in

our regional allocation framework. We added China to Overweight on Nov 21, 2013. Since
then, the MSCI China index has dropped 5%, but has outperformed MXAPJ and EM by
6pp and 13pp in US$ respectively.

From an absolute-return standpoint, our sum-of-the-part analysis suggests 7% 12-month

potential price returns for MSCI China (cum ADRs) and 10% for CSI300, largely
driven by forward earnings accruals, with insignificant contribution from multiple changes.
Our index target P/E multiples are close to the respective markets mid-cycle averages,
reflecting our view that valuations look largely fair vs. our envisaged macro setup. In USD
terms, we forecast 7% returns for both H and A, given our USDCNY assumption.

While we no longer explicitly forecast price returns for HSCEI and HSI (as we dont view
them as the most sensible proxies for their underlying economies), our market/sector-based,
return-mapping analysis implies a 12m level of 10500 and 24000 for HSCEI and HSI,
translating into 6% and 7% potential upside. See the next section for details about our
earnings forecasts and valuation assumptions.

In a world where aggregate index returns are subdued and growth is in short supply, we
continue to advocate a two-pronged approach to position in the market:
1.

Building core holdings around New China stocks as they have proven to be
alpha generating over the past few years and will likely further deliver stronger organic
earnings growth over Old China in the years to come.

2.

Tactically engaging in Old China, especially at times when growth faces cyclical
threats, policy loosening signal is strong, market confidence is fragile, profitability
expectations are low, and cyclical recovery stories arent expensively priced.

These top-down views drive our thematic thinking and sector recommendations summarized in
later sections.
Exhibit 34: Background: China H has been operating under a fat trading range since 2010
Average chg or peak/trough levels
HSCEI Index Level
fPE: 10.0X
# of obs. # of days Change
fPE
tPB
RSI
15000
14000
13000

fPE: 10.7X

+14%

fPE: 10.0X

143
135
85

8.9x
6.4x
7.2x

1.5x
1.1x
1.0x

fPE: 7.8X

+35%

+46%

32%
-27%
9%

+30%

fPE: 7.3X

+24%

-24%

10000
-41%

8000

fPE: 7.1X

fPE: 6.4X

fPE: 7.2X
-11%

fPE: 6.5X

-20%

-27%

9000

70
25
42

fPE: 9.2X

fPE: 8.7X

12000
11000

6
6
-

Up to peak
Down to trough
Current (Up)

+45%
-38%

fPE: 6.2X

+9%

fPE: 6.6X

fPE: 5.9X

Dec-15

Sep-15

Jun-15

Mar-15

Dec-14

Sep-14

Jun-14

Mar-14

Dec-13

Sep-13

Jun-13

Mar-13

Dec-12

Sep-12

Jun-12

Mar-12

Dec-11

Sep-11

Jun-11

Mar-11

Dec-10

7000

Source: Bloomberg, FactSet, I/B/E/S.

17

2015 12 3

Exhibit 35: There have been many mini-cycles in terms

of macro and policy cyclicality over the past 5 years

China FCI excl. equity

10

130

MXCN index

97

120

MXAPJ index

99

110

101

100

103

90

8
6
4
FCI means tightening
financial conditions

105

80

Aug-15

May-15

Nov-13

Feb-15

70

Jan-16

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

Nov-14

MXEF index

Aug-14

12

China FCI excl. equity (leading 3m) - RHS

Indexed price returns (in USD terms)

95

May-14

14

China CAI

Feb-14

China CAI

Exhibit 36: Despite the ups and downs and widespread

concerns about Chinas macro situation, China has
outperformed the region and broader EM since late 2013

Source: Goldman Sachs Global Investment Research.

Source: Bloomberg.

Exhibit 37: We lower China to MW from OW in our

regional allocation framework from a relative risk/reward
standpoint

Exhibit 38: 1Q is typically challenging for offshore

equities, while A shares may see liquidity headwinds this
year

End-16 forecasts (%)

Local
USD
price
total
return
return
13
13
12
10
9
12

Index

Target
P/E (X)

Index
target
(12m)

Overweight

India
Philippines
Indonesia

NIFTY
PCOMP
JCI

16.5
17.5
14.0

9,000
7,900
5,100

Marketweight

China
Singapore
Taiwan
Australia

MXCN
FSSTI
TWSE
AS51

10.8
12.0
12.0
15.5

65.2
3,100
9,000
5,600

7
8
6
6

9
7
6
6

Underweight

Korea
KOSPI
Hong Kong
MXHK
Malaysia
FBMKLCI
Thailand
SET

10.0
14.0
14.0
12.0

2,170
13,100
1,620
1,330

7
-2
-4
-2

-1
0
-8
-9

11.8

425

Allocation

Market

Asia Pacific ex Japan (USD) MXAPJ

Source: Goldman Sachs Global Investment Research.

10Y median quarterly returns

8%
7%
MXCN
7%
CSI300
6%
5%
4%
3%
3%
2%
1%
0% 0%
1%
0%
0%
1Q
2Q
3Q

7%
6%

4Q

Source: Bloomberg.

Exhibit 39: Our sum-of-the-part analysis suggests 7% and 10% potential price returns for A and H shares in 2016
Sector

Index
weight

EPSg (GS)

16E
17E
MXCN sectors (cum ADRs)
18%
0%
-10%
Banks
6%
-20%
111%
Energy
27%
35%
28%
IT
Others
48%
6%
5%

MXCN

100%

5%

7%

EPSg (I/B/E/S) Current Target Implied

fPE (x) fPE (x) upside
16E
17E

Index
weight

EPSg (GS)
16E

17E

EPSg (I/B/E/S) Current Target Implied

fPE (x) fPE (x) upside
16E
17E

2%
13%
35%
7%

8%
46%
32%
13%

4.9
13.5
28.4
11.5

5
7
28
12

-8%
13%
28%
9%

CSI300
Banks
Energy
IT
Others

20%
3%
6%
71%

0%
9%
26%
11%

-10%
15%
24%
12%

6%
23%
30%
12%

8%
10%
25%
14%

6.4
19.6
31.8
16.8

7
18
32
18

-4%
6%
24%
20%

6%

12%

10.9

CSI300

100%

7%

4%

10%

11%

12.6

MXCN Index Target

Current level
End-2016 SOTP target
potential upside
fPE at end-2016 (x)

61

65
7%
10.8

Source: FactSet, CEIC, MSCI, Goldman Sachs Global Investment Research.

Sector

CSI300 Index Target

3592
Current level
4000
End-2016 SOTP target
10%
potential upside
13.4
fPE at end-2016 (x)

Source: FactSet, CEIC, Goldman Sachs Global Investment Research.

18

2015 12 3

#7: Earnings/valuationsUnexciting growth; fair valuations

Earnings growth for offshore equities has been lackluster since 2011. In fact,
without the contribution from newly added ADRs, earnings growth for MSCI China would
have been -1% in 2015, the first negative growth print since 2008.
For 2016 and 2017, we forecast MXCN EPS (cum ADRs) to grow 5% and 8%
respectively, based on our top-down, regression-based models and our analysts bottom-up
earnings expectations on certain sectors which are subject to supply/demand shocks (e.g
Tech and Energy). The key positive growth contributors are Tech (31% EPS CAGR for 15-17)
and select deep cyclicals which have had consecutive years of net losses.

Profitability (net margin) and top-line growth for most Old China sectors are at the low end of
their respective historical ranges, but the simple notion of profit normalization may not be
applicable to many of these sectors in a new normal growth era where the underlying
demand profile is structurally evolving.
We forecast a similar growth profile for the onshore market in 2016, but expect earnings to

further decelerate into 2017 because of a smaller earnings uplift from Energy and lower
index weights from Tech software vs. the MSCI China index.

Headline index, ex-banks, average, and median PEs are close to their mid-cycle
averages for H shares (including ADRs) but moderately expensive relative to
ranges for A shares, especially for small-mid caps, which have rallied 80% ytd (ChiNext)
and are currently priced at 45x forward earnings, 1.0 s.d. While the risk of collateral damage
to the broader market should have declined alongside margin deleveraging (now at
Rmb1.2tn, 2.2% of market cap), high valuations and the speculative nature of small/mid caps
are major sources of concern to our A-share market view.

Absolute valuations carry low analytical and forecasting value as macro conditions change.
Our top-down valuation analysis, which simplifies absolute valuations into a growth (CAI) and
rates (7D repo) component, suggests that both the offshore and onshore markets are
fairly valued. Also, our Dividend-Discount-Model (DDM) points to only moderate upside for
both markets. In other words, we dont see significant room for valuation multiple expansion
at the aggregate index level given our macro expectations and earnings forecasts, although
equities look attractively priced relative to competing asset classes including fixed income
and property.

Exhibit 40: Earnings growth has been lackluster since

2011
EPS growth
50%

MXCN (cum ADRs)

40%

CSI300

30%
20%
10%

7% 7%

0%

5% 4%

-10%

Source: FactSet, MSCI, Goldman Sachs Global Investment Research.

2017E

2016E

2015E

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

-20%

Exhibit 41: We forecast moderate acceleration of EPS

growth in 2016
EPS growth forecast
MXCN (with ADRs)
Sector
2015E 2016E 2017E 2015E
Cons.
Cons.
GS
GS
Banks
-3%
0%
-10%
6%
Energy
-55%
-20%
111%
19%
IT
0%
35%
28%
31%
Others
12%
6%
5%
24%
Headline (GS)
5%
7%
Headline (Cons.) 2%
6%
12%
10%
Banks
Energy
IT
Others

CSI300
2016E 2017E
GS
GS
0%
-10%
9%
15%
26%
24%
11%
12%
7%
4%
10%
11%

EPS growth top-down forecast method

GS top-down estimates
GS bottom-up estimates (I/B/E/S if not covered)
GS bottom-up estimates (I/B/E/S if not covered)
Regress Sales growth with China CAI and GLI
Regress Net margin with China CPI, Brent and GLI

Source: CEIC, FactSet, MSCI, Goldman Sachs Global Investment Research.

19

2015 12 3

Exhibit 42: Most Old China sectors see profitability

hovering at the low end of their respective ranges
ROE by GICS industry group
30%
New China
25%

+/- 1s.d. for the past 10Y

Exhibit 43: 2016 EPS revisions have been weak,

particularly in Energy and Materials

2014 ROE

2016 Sector EPS revision, MSCI China

105

Old China

100

20%
15%

Utilities
Telcos
Healthcare
Industrials
I.T.
Financials
Cons Disc

95

10%

90
85

MXCN
Energy: 51

80

Materials: 65

Cons Stap

Oct-15

Sep-15

Aug-15

Jul-15

Jun-15

May-15

Apr-15

Mar-15

Feb-15

75
Jan-15

Software & Services

Insurance
Pharmaceuticals
Commercial Services
Media
Health Care Services
Banks
Household Products
Autos
Consumer Durables
Diversified Financials
Real Estate
Utilities
Food & Beverage
Telecom
Tech Hardware
Semiconductors
Transportation
Energy
Consumer Services
Capital Goods
Retailing
Staples Retailing
Materials

0%

Dec-14

5%

Source: FactSet, Goldman Sachs Global Investment Research.

Source: FactSet, MSCI, I/B/E/S.

Exhibit 44: Earnings-based valuations for H shares are

close to mid-cycle levels excluding banks

Exhibit 45: Small caps are commanding high multiples in

A shares
Forward 12M P/E (x)

Jul-15

Dec-14

May-14

Oct-13

Mar-13

Aug-12

Jan-12

Jul-08

Feb-09

Dec-07

Oct-06

May-07

Mar-06

Jan-05

Aug-05

Jul-15

Dec-14

Oct-13

May-14

Mar-13

Jan-12

Aug-12

Jun-11

Apr-10

Nov-10

Feb-09

Sep-09

Jul-08

Dec-07

15

Oct-06

10

May-07

25

Mar-06

15

Jan-05

35

Aug-05

20

Jun-11

45

MXCN (median) 11.6x -0.5sd

Apr-10

MXCN (average) 13.0x -0.3sd

25

CSI300 13.3x -0.2sd

CSI300 ex-banks 17.8 +0.1sd
CSI300 (average) 51.3x +3.0sd
CSI300 (median) 24.2x +0.8sd

55

MXCN ex-banks 15.0x +0.4sd

Nov-10

MXCN 11.1x -0.4sd

Sep-09

Forward 12M P/E (x)

30

Source: FactSet, I/B/E/S.

Source: FactSet, I/B/E/S.

Exhibit 46: Our top-down, macro factor model suggests

the current index PE is fairly valued

Exhibit 47: Equities, offshore in particular, look

inexpensively valued relative to competing asset classes

MXCN f-P/E (X), before ADR inclusion

15
Actual
14

Yield (%)
14%

Fitted

China cross asset yield comparsion

12%

13

10%

12

8%

11

9.8X

10

Earnings (H):
10.9% +0.6sd
Earnings (A):
7.6% -0.4sd

6%
4%

9.2X

2%

Source: FactSet, MSCI, Gaohua Securities Research.

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jul-12

Jan-13

Jan-12

Jul-11

Jan-11

Jul-10

Jul-09

Jan-10

Jan-09

Jul-08

Dec-16

Dec-15

Dec-14

Dec-13

Dec-12

Dec-11

Dec-10

Dec-09

Dec-08

Note: Based on a 2-factor regression model using China growth (CAI) and
liquidity (7-day repo rate) to model the headline PE index level.

Jan-08

0%

Bond:
3.2% -1.1sd
Dividend (H):
3.0% +0.5sd
Rental: 2.1%
-1.1sd

Note: Rent yield is the median of 5 largest cities - Beijing, Shanghai,

Guangzhou, Shenzhen and Tianjin.
Source: FactSet, MSCI, Goldman Sachs Global Investment Research.

20

2015 12 3

#8: Liquidity: Still conducive, but less so than in 2015

Favorable liquidity was one of the key drivers for our positive stance for Chinese stocks in 2015,
but we believe the bar for arguing for a liquidity-led re-rating is considerably higher in 2016. We
group our liquidity views into 3 main categories: Macro, micro, and index flows.

Macro flows: A positive monetary phenomenon to equities

As discussed in section 2, the macro liquidity backdrop has been conducive to asset
price performance so far in 2015 and will likely remain so in 2016 given the conventional
easing (benchmark rates, RRR, 7D repo cuts) and other monetary operations (e.g. MLF, SLF)
that we expect to be conducted next year.

In the equity market, our Dividend Discount Model (DDM) suggests every 50bps reduction
of Cost of Equity (COE) could translate into 10% to 15% valuation upside for both
H and A shares, everything else being equal.

The key risks to this view are: a) inefficient monetary transmission mechanism whereby
macro easing is ineffective in reducing COE; and b) an abrupt Rmb devaluation, which, if
mishandled, could lead to sizable capital outflows and a sharp tightening of financial
conditions.

Micro flows: Secular asset reallocation flows offset by higher equity supply and
lower leverage

We see what we branded as asset reallocation flows by Chinese households remaining

a structural trend as we estimate that real assets (property) account for 60% of Chinese
households balance sheets, one of the highest levels among major economies globally; on
the other hand, they only allocate 6% of their total assets in equities, the lowest globally. A
potential recovery in the real estate market could however slow the allocation shifts in
2016, according to our state-space regression model. See Stay tactically positive on
targeted/reform loosening, June 23, 2014.

Additionally, we envisage an incrementally less favorable liquidity/equity supply setup,

notably the resumption of IPOs and expiration of selling bans from major
shareholders in A shares in 1Q, lingering concerns about National teams exit, lower
margin financing balance/ratios than in 2015 on more stringent regulatory oversight, and
potentially higher equity issuance in 2016 on the back of the pending approval-based to
registration-based IPO reform.

Specifically, we forecast total new equity issuance amounting to Rmb1.2tn (IPO plus
follow-ons), representing 2.2%/5.6% of the current total/free-float market cap in A shares, up
from 2.0%/4.9% from 2015, during which the IPO window was shut for 4 months. See China
A-share 2016 Outlook: Structural opportunities, but higher risks.

Index-oriented liquidity: Underappreciated, and significant/long-lasting flows

As flagged in our recent reports, we estimate that the confirmed inclusion of 14 ADRs to
MSCI benchmarks could usher in as much as US$94bn of net buying for these names,
averaging 29 days of their ADVT, assuming US$1.7tn of assets (85% active, 15% passive) is
tracking the MSCI EM index. See China Musings: 14 ADRs added to the MSCI universe; a
'New' chapter for Chinese equity indexes, Nov 13.

For A shares, our base case still calls for MSCI making the announcement of including A
shares in its benchmarks in May 2016, with actual implementation starting mid-2017. In this
case, we estimate the initial inclusion could translate into US$40bn of active and passive
buying for A shares assuming a 10% inclusion factor (IF). Looking further out, the
inclusion factor for A shares should rise as the domestic equity market continues to liberalize.
Using Korea and Taiwan as a template, we expect it could take as long as 9 years to get A

21

2015 12 3

shares completely included in the benchmarks (i.e. IF to 100%), translating into US$332bn

of net inflows to A shares over the next decade, based on current prices.
Exhibit 48: We estimate that every 50bps reduction of
COE could boost equity valuations by around 13% to 15%
80% 71%
60%

18%

90%

26%

CSI300

40%
32%

18%

70%

12%

6%

2%

1%

0%
-4%

-4%

-9%

-20%

-14%

-19%

-23%

-8% -13%

-26% -30%
-33% -36%
-39%

-40%

5%
5%

60%

8.0%

8.5%

9.0%
9.5%
Cost of equity (COE)

10.0%

10.5%

11.0%

35%

17%

33%

18%

40%

3%
6%

30%

8%

13%

36%

50%

9%

2%
6%

Others
Other
Securities

17%

Insurance &
Pension
Mutual Fund

1%
Equity

18%
34%

Currency &
equivalent

6%

18%

77%

60%

20%

-60%

10%
7%
4%

36%

80%

25%

15%
8%

100%

MXCN

50%

40%
20%

Composition of household total balance sheets

Valuation changes based on different COE

assumptions

60%

Exhibit 49: Asset diversification away from real assets to

financial assets (equities) remains a structural theme in
China...

49%

41%

35%

Real estate

10%

18%

0%
CN

JP

UK

KR

AU

TW

US

Note: China as of Aug, 2015, Taiwan as of 2012; Others as of 2Q2014.

Source: China NBS, Bloomberg, Goldman Sachs Global Investment Research.

Source: FactSet, CEIC, Goldman Sachs Global Investment Research.

Exhibit 50: ...but the incremental flows from property to

equities may slow in 2016

Exhibit 51: We estimate total equity supply next year

could be higher than in 2015

Investment demand ratio (%)

46%

(Rmb bn)

41%

40%
30%
27%

18%

600

18%
12%

1,000

2016E

2015

2014

2013

2012

2011

2010

2009

2008

-200

2007

2016E

2014

2013

2,000

200

3% 5%

2012

2011

2010

2009

2008

2007

2006

2005

2002

1%

2004

6%

2003

Investment demand as % of total demand

(Worldunion survey)
Investment demand as % of total demand
(based on our model)

11%

3,000

400

2006

16%

2005

24%

5,000
4,000

800

25%

2015E

21%

6,000

1,000

29%

28%

26%

1,200

31%

2004

31%

1,400

38%
34%

36%

Rights offering
Secondary equity offering Rmb
IPO
1.2 tn
CSI300 Index (RHS)

Source: WDI, Penn World Table, IMFWEO, BIS, Goldman Sachs Global
Investment Research.

Source: FactSet, CEIC, Wind.

Exhibit 52: Stock deleveraging has stabilized but unlikely

to return to its recent peaks soon

Exhibit 53: The potential inclusion of A shares to MSCI

may usher in significant and long-lasting flows

Margin balance as % of total market cap

4.0%

China

US

Taiwan

Korea

Japan

4.0%

Source: Bloomberg, Wind.

2015

2014

0.0%

2013

0.5%

0.0%

2012

0.5%

2011

1.0%

2010

1.5%

1.0%

2009

1.5%

2008

2.0%

2007

2.0%

2006

2.5%

2005

3.0%

2.5%

2004

3.0%

2003

3.5%

2002

3.5%

A-share
inclusion
factor
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%

MSCI EM index
China's
A-share
ADR net
A-share
ADR
weight
net inflow
inflow
weight
weight
(H+ADR+A)
(US$bn)
(US$bn)
31%
2%
40
5.5%
94
32%
5%
79
5.4%
92
34%
7%
115
5.3%
89
35%
9%
150
5.1%
87
37%
11%
184
5.0%
86
38%
13%
216
4.9%
84
39%
15%
247
4.8%
82
40%
16%
276
4.7%
80
42%
18%
305
4.6%
79
43%
20%
332
4.5%
77

Source: FactSet, MSCI, Goldman Sachs Global Investment Research.

22

2015 12 3

#9: SectorProactive strategy is needed; start with a defensive tilt

MSCI China is down 9% over the past 20 quarters (5 years), but the best- and worstperforming sectors have generated 264% long-short alpha (29% return CAGR). In a
less radical example, the top- and bottom-3 sectors (average returns) have resulted in 139%
and 33% spread in the past 5 years and 12 months.

Significant return divergence aside, sector leadership rotation has also been high on
average, except for Tech, the 11 key sectors have had roughly an equal chance of being in
out- and underperforming bucket over the past 5 years.

These observations suggest a proactive and nimble investment approach/mindset is

required to generate outperformance at the sector level.

Our ytd sector recommendations, on an equal-weighted basis, have resulted in 26% longshort returns, vs. -8% for MSCI China.

Overweights

Tech/Internet (Stay OW): We believe this remains one of the most exciting and investable
growth stories in the New China space, and in the Chinese equity universe more broadly.
Intensifying competition may pressure margins but we believe large-scaled portal
operators/service providers with sticky customer bases will prevail. Post the inclusion of
ADRs, the Tech sector will account for 27% of MSCI China by mid next year (from 14%),
thereby ushering in meaningful active and passive inflows to the sector, especially given
investors significant underweight position in the sector on a pro-forma basis.

Telecoms (Upgrade to OW): The sector outperformed in 1Q15 when macro growth
decelerated given its defensive nature, and we expect this pattern to repeat in 1Q16. 4G
capex cycle growth may have already peaked, 4G adoption may accelerate and improve
data APRU/revenue, tower sharing could enhance long-term sector investment rationality,
and potential corporate restructuring could boost valuation, in our view.

Healthcare (Upgrade to OW): Another key constituent in our New China universe. We
believe the structural growth story remains intact and our analysts expect the healthcare
companies under our coverage to deliver a stable mid-to-high-teen revenue and earnings
growth in 2016. This also fits into our defensive orientation to start the year given its relatively
low market beta.

Property (Stay OW): Our envisaged sector recovery underpins our continuing positive view
on the sector (we upgraded the sector to OW in March 2015). A tough cyclical growth path in
1Q could be a headwind to the sector but we would accumulate on any major weakness.

Marketweights

Energy (Upgrade to MW): While we expect oil and coal prices to stay low for longer (-5% and
-8% upside on our commodity teams 15/16 average price forecasts), and earnings to further
drop in 2016 (-20% by GS forecast), we think the combination of a close to 30% drop ytd (and
46% drop from the 2014 peak) and record-low P/B ratios (0.7x P/B,
-1.8x s.d.) suggests that a good deal of the downside risk in commodity prices is already
priced in. Additionally, earnings growth could stage a meaningful rebound in 2017 alongside a
normalization in oil prices (GS forecast average Brent price to reach US$65/bbl in 2017),
which the market will start to discount in 2H16, in our view. A more mature cycle in terms of
the anticorruption charges in the Energy sector may also lead to better implementation of
SOE reform, everything else being equal.

Insurance (Downgrade to MW): We continue to expect solid growth in new business

value in 2016, given the liberalization of investment channels and increased focus on long-

23

2015 12 3

term/protection products from both regulators and industry players. However, our restrained
near-term view on A shares leads us to dial back our optimism on Chinese insurers given
their direct exposure in the A-share market.

Utilities (Downgrade to MW): Although the key positive arguments regarding falling coal
costs, improving capex discipline, strong free cash flow (and dividend) growth potential, and
asset injection optionality remain largely intact, lingering concerns about tariff cuts could limit
the potential for sector re-rating.

Underweights

Banks (Downgrade to UW): While the sector is trading at record-low valuations (PE, PB,
and DY), slowing macro growth and further easing of monetary policy will likely pressure topline growth, net interest margin (NIM), and provisioning charges. I/B/E/S consensus forecast
of 5% EPS CAGR for 2015-2017 looks optimistic to us against a challenging operating
backdrop. Current bank share prices are implying around 7% NPL ratios, but we dont
foresee a sustainable re-rating for the sector until more decisive reforms are taken and more
NPLs are recognized, which will likely trigger more short-term pain (earnings and sentimentwise) before fundamental overhangs can be removed.

Discretionary (Stay UW): The addition of ADRs makes this the 4th largest sector in MSCI
China by market cap (from 5% to 8%), and hence the sector could face upside liquidity risks
given on fund inflows. However, we see the tradeoff between growth and valuation as fair
given its above-mid-cycle PE, and the sector has rallied 22% on a cum-ADRs basis. We
prefer Tech to express our positive New China bias.

Materials (Stay UW): We see limited fundamental reasons to re-engage now given our
near-term and longer-term macro expectations despite the sectors low valuations (0.8x P/B,
-1.2x s.d.). The sector now only represents 1% of MSCI China index cap on a pro-forma
basis.

Q1

2011
Q2
Q3

Cyclicals

Consumer Discretionary

-3%

7%

Information Technology

11%

4%

Industrials

-5%

Comdy

Exhibit 54: Significant sector rotations in the fat and flat trading range

Energy

8%

Materials
Banks

Defensives

Financials

Quarterly price return

(LOC)

2012
Q2
Q3

2013
Q2
Q3

Q4

Q1

Q4

Q1

-29%

5%

10%

-17%

-24%

-2%

32%

-3%

1%

22%

-10%

-7%

12%

-1%

0%

16%

-11%

-35%

14%

11%

-9%

-2%

18%

-4%

-4%

-20%

4%

10%

-11%

5%

11%

-7%

8%

-5%

-41%

6%

10%

-17%

7%

15%

-8%

-23%

11%

8%

-11%

-33%

19%

8%

-11%

1%

20%

1%

-13%

11%

Real Estate

5%

-3%

-39%

20%

15%

13%

1%

24%

-7%

-6%

9%

Insurance

-8%

-3%

-35%

7%

7%

0%

4%

14%

-14%

-9%

Diversified Financials

-1%

-15%

-43%

43%

-6%

-10%

-13%

46%

-17%

Telecom Services

-5%

-6%

-11%

3%

19%

-19%

0%

16%

2%

Consumer Staples

-6%

10%

-21%

6%

6%

-8%

6%

2%

-1%

Utilities

8%

-3%

-14%

14%

7%

5%

8%

13%

22%

-6%

Health Care

-2%

-8%

-23%

-13%

16%

-6%

19%

-6%

4%

-5%

MSCI China

3%

-4%

-26%

8%

10%

-8%

4%

13%

-4%

-9%

11%

2014
Q2
Q3

Q4

Q1

2015
Q2
Q3

Q4

-6%

2%

0%

-6%

19%

-5%

-21%

10%

-25%

7%

10%

-1%

-3%

32%

0%

-22%

19%

203%

Since
2011

Q4

Q1

18%

0%

31%

18%

-9%

11%

10%

-7%

0%

0%

14%

8%

9%

-19%

3%

-19%

-19%

11%

-1%

-8%

11%

-2%

-14%

-1%

1%

-32%

7%

-50%

6%

0%

-8%

0%

8%

7%

7%

-27%

-4%

-52%

0%

-7%

4%

-3%

22%

0%

10%

-29%

5%

-17%

-7%

-7%

-11%

1%

13%

5%

4%

-21%

19%

6%

10%

17%

-9%

-4%

4%

36%

10%

7%

-23%

7%

-5%

-14%

12%

26%

-23%

2%

6%

41%

-1%

7%

-41%

21%

-35%

-9%

19%

14%

-7%

20%

2%

-10%

10%

-2%

-22%

20%

19%

3%

6%

2%

-7%

-4%

-9%

-3%

0%

5%

-17%

0%

-30%

2%

17%

-2%

10%

-6%

1%

1%

8%

-15%

-6%

69%

0%

24%

2%

-5%

15%

-5%

3%

-5%

-14%

15%

-8%

4%

-6%

3%

0%

7%

8%

4%

-23%

7%

-8%

Source: FactSet, MSCI.

24

2015 12 3

Exhibit 55: Plenty of alpha opportunities on active

allocation strategy

Exhibit 56: Not many trends to follow except for Techa

difficult setup for buy-and-hold investors

Quarterly return spreads between

top and bottom 3 performing sectors (avg)

pp
50

# of top/bottom 3 performing quarters, past 5 years

12

# of top 3

10

40

# of bottom 3

30

Alpha ratio [RHS]

5
4

Alpha ratio = 1

2015

Source: FactSet, MSCI.

Energy

Banks

Div Fins

Property

Materials

2014

Cons Stap

2013

Industrials

2012

Insurance

2011

Cons Disc

Telecom

Info Tech

10

Utilities

20

HealthCare

Avg: 27 pp

Source: FactSet, MSCI.

Exhibit 57: We are OW Tech, Telecoms, Healthcare, and Property to start the year

GS
Strategy
View
Cons. Disc.
Cons. Stap.
Energy
Financials

Property
Banks
Insurance/Other fins.
Health care
Industrials
Information technology
Materials
Telecoms
Utilities
MSCI China (MXCN)

UW
MW
MW
MW
OW
UW
MW
OW
MW
OW
UW
OW
MW

Correlation with Macro

Factors
View
Change

Growth

Liquidity

CAI

GLI

M2

FCI

Index
YTD
YTD
Wgt
Return
Return
(%, pro
(%, pro
(%)
forma)
forma)
6%
3%
7%
37%
6%
19%
12%
2%
8%
23%
1%
9%
4%

2%
-12%
-27%
-11%
11%
-17%
-9%
10%
3%
30%
-26%
-2%
-12%
-8%

14%
-12%
-27%
-11%
11%
-17%
-9%
10%
3%
11%
-26%
-2%
-12%
-5%

16E
P/E
(X)

17E
P/E
(X)

16E
P/B
(X)

14.3
19.0
13.3
6.4
7.7
4.9
10.9
18.5
10.2
27.1
12.2
12.6
9.6
10.2

12.5
17.1
9.1
5.9
6.8
4.5
9.8
15.5
9.1
20.7
9.8
11.6
8.9
8.9

2.2
2.8
0.7
0.9
0.9
0.7
1.4
2.7
1.2
5.2
0.8
1.3
1.3
1.3

15-17E EM Fund
EPS
OW/UW
CAGR
(pro
(%)
forma)
16%
11%
29%
6%
13%
5%
4%
19%
11%
33%
20%
8%
5%
10%

UW
MW
UW
UW
UW
UW
UW
MW
UW
UW
MW
UW
UW

UW

Z scores

f-P/E

t-P/B

0.7
(1.9)
1.8
(0.7)
(0.2)
(0.8)
(1.2)
(0.3)
(0.6)
1.0
0.5
0.3
(1.7)
0.3

(0.3)
(1.9)
(1.8)
(1.1)
(0.8)
(1.2)
(1.0)
0.8
(0.0)
(0.3)
(1.3)
(1.2)
(0.7)
(0.9)

Note (1): Valuation z scores are compared with the past 5-year monthly history; Lower z scores mean more favorably priced fundamentals and valuations.
Note (2): Ytd return is based on bottom-up calculation; Fundamentals and valuations are based on I/B/E/S consensus.
Note (3): Correlation with macro factors is calculated since 2010. "" indicates sectors ranked in the top 33%ile (i.e. more correlated), and "" indicates sectors
ranked between 33%ile and 66%ile
Note (4): Pricing as of Dec 1, 2015.
Source: FactSet, Bloomberg, MSCI, I/B/E/S, Goldman Sachs Global Investment Research.

25

2015 12 3

#10: EventsA busy calendar

2016 will likely be another eventful year
Externally, the US presidential election will be held in November while the Fed may
continue its monetary policy normalization over the course of 2016.
Outside of the US, our economists expect the ECB and BoJ to step up their respective QE
programs, and geopolitical tensions and economic stresses, including from significant correction
of commodity prices, could keep equity risk premiums at high levels.
Regarding China, 2016 will be the maiden year of the implementation of the 13th Five Year
Plan, and SZ-HK Connect will likely be announced and implemented in 1H16, followed by the
discussion of A shares going into MSCI benchmarks. Additionally, policy intensity and
development regarding the anticorruption campaign could have far-reaching macro and
investment/trading implications, in our view.
We summarize the key events which have direct implications on China as follows.
Exhibit 58: These external and domestic events may have significant investment
implications on Chinese stocks in 2016
Month

Country

Nov
17 Dec
Dec
Dec

China
US
EU
China

2016
2016
2016
1Q

China
China
China
China

1H
Feb - Apr
Mar
May - Jun
May
May
Aug - Sep
Oct - Nov
Oct
Oct
8 Nov

China

China
China
United States

late 2017

China

China
China
China

Events/elections/government changes and meetings

2015
A-share IPO resumption
GS proposed date of US rate hike
ECB meeting
Central Economic Work Conference
2016
Maiden year of the 13th Five Year Plan
'National team' exit
Anti-corruption campaign
A-share major shareholder selling ban expiration
Shenzhen - Hong Kong Stock Connect
FY15 reporting season
NPC & CPPCC 2016 Annual Sessions
1QFY16 reporting season
MSCI China A Share inclusion decision
MSCI China ADR inclusion - 2nd batch
2QFY16 reporting season
3QFY16 reporting season
The Sixth Plenum
Actual inclusion of RMB in the SDR basket
Presidential elections
2017 onwards
19th National congress of CPC

Source: Consensus Economics, Bloomberg, Goldman Sachs Global Investment Research.

26

2015 12 3

1. US policy cycle (timing: over the course of 2016)

Our economists expect the Fed to start normalizing monetary policy in its Dec 2015
meeting, raising the Fed Fund rate by 25bps, the first policy rate increase since 2005. After
the December move, they also expect the Fed to raise rates 4 times (once every quarter),
100bps in total, vs. market consensus of 70bps during 2016.

Historically, Chinese equities have exhibited relatively low sensitivity to the Fed
monetary cycle largely due to the fact that: (i) Rmb has been on a steady appreciating path,
strengthening 30% and 39% on a nominal and trade-weighted basis over the past decade; (ii)
offshore equities are mostly denominated in HKD (or USD in case of ADRs), which is pegged
to the USD; and, (iii) capital outflows hadnt been a major source of macro/liquidity concern
until recent quarters.
However, given the uncertainty and fragility of the quasi-peg vis-a-vis a strong USD, we
believe the speed and magnitude at which US rates could be rising are consequential to
equity returns. Hence, hedging a significant Rmb devaluation risk appears sensible
to us.

Exhibit 59: Our economists expect the Fed to raise rates

by 100bps in 2016

Forward implied

Exhibit 60: Chinese equities have shown relatively low

sensitivity to US rates relative to other regional markets
but a more volatile Rmb exchange rates could change the
equation
Rolling t-stats to US Rate on equity return
0.5
US rate sensitivity without Rmb as
a factor
0

GS forecasted FED fund rate (%)

2.8

2.8

2.4

2.4

-0.5

1.6

1.6

-1

1.2

1.2

-1.5

0.8

-2

*As of Nov 27

Source: Haver, Goldman Sachs Global Investment Research

Nov-15

3M 6M 12M

Aug-15

-2.5

Apr-15

Dec-17

Sep-17

Jun-17

Mar-17

Dec-16

Sep-16

0
Jun-16

0
Mar-16

0.4
Dec-15

0.4

US rate sensitivity with

Rmb as a factor

Jan-15

100
bps

Jun-14

0.8

Oct-14

Note: Based on a 4-factor model, using monthly data in the past 10 years
Source: FactSet, MSCI, Haver, Goldman Sachs Global Investment Research

2. A-share liquidity headwinds (timing: 1Q16 and 2016)

On November 6, the CSRC announced that the IPO window could re-open after being
frozen since early July. 28 companies are currently in the pipeline, with an estimated
aggregate issuance size of Rmb10bn (US$1.6bn). We think this is an encouraging move
in the sense that: (a) capital raising is an integral part of a well-functioned stock market and
primary issuance cant be halted indefinitely; and (b) it sends a positive signal to the market
that policymakers regard the current market supply/demand as balanced and the period of
excessive volatility may be over. However, from a tactical standpoint, history suggests the Ashare market tends to trade sideways to slightly down shortly after resumptions
became effective.

On July 8, the CSRC banned company shareholders with stakes of more than 5%
from selling for the next 6 months, as a part of the regulators effort to provide an
external stabilizer (reduce supply) to smooth out volatility during the sharp market correction
in July. These bans will expire in 1Q16 and we estimate that major individual
shareholders with over Rmb1.2tn of stock holdings could be incentivized to sell,
creating another liquidity risk to the market.

27

2015 12 3

Besides these short-term liquidity hurdles, another important equity supply issue which could
affect market sentiment occasionally in 2016 is how the Chinese government will handle the
exit of the direct equity purchase from the National team during the market selloff,
which we estimate to be around Rmb1.8tn from July to October. While visibility is admittedly
low at present, international experiences (HK, US, and Japan) suggest that marketsupportive policies are usually carried out for years and also end with very cautious exits.
And in Chinas case, internal transfer could be another option (i.e. offloading shares to
national pension funds, and sovereign investment corps) which should have limited direct
impact on supply in the secondary market. See China Musings: How much has the
government bought in the market?, August 5.

A-share market return:17%

502

500
386

400

279

300

213

200
100

388

160

134

69

24

100% to 120%

Price returns since July 8

60% to 80%

40% to 60%

80% to 100%

Note: IPO resumption date is the date when first IPO was launched following

Total A shares held by major (>5%) individual shareholders (Rmb bn)

600

20% to 40%

SHCOMP performance
1W
+1M
+6M
+1Y
-4%
-2%
7%
-3%
-7%
-4%
-8%
12%
1%
-1%
47%
69%
-6%
2%
-8%
-18%
-2%
4%
-10%
5%
-7%
2%
29%
148%
5%
16%
10%
-17%
-2%
3%
1%
65%
-3%
2%
8%
33%

0% to 20%

+1D
-1%
1%
3%
-1%
2%
1%
-1%
0%
0%

-20% to 0%

IPO resumption
date
12/8/1994
6/10/1995
1/4/1996
11/3/2001
1/24/2005
6/5/2006
6/30/2009
1/7/2014
Average

Exhibit 62: The expiration of major shareholders selling

ban could lead to short-term liquidity pressure in 1Q

-40% to -20%

Exhibit 61: History suggests that resumption of IPOs has

tended to pressure market returns initially

-60% to -40%

the suspension period.

Source: Bloomberg, Xinhua News.

Source: Wind.

3. SZ-HK Connect (timing: 1H16)

Inclusion of Shenzhen into the Connect regime would complete the creation of a singular
China market from a foreign investors' accessibility standpoint, which we believe is a key
prerequisite for A-share inclusion into global equity benchmarks. This will also expand
global investors' investable universe, especially in the New China category.

Our base-case calls for the announcement to be made in early 1Q and the new trading
channel to be up and running in early 2Q, assuming that Chinese regulators are keen to
push for the A-share inclusion to MSCI in May 2016.

Assuming full liberalization, Shenzhen would add 1718 companies (1062 of which have over
US$1bn market cap) and US$3.2tn of listed market cap to investors investable universe.
It will also offer a vastly different set of new (compared with Shanghai and HK), and arguably
exciting, opportunities to global investors as the incremental market cap is concentrated in
New China sectors such as IT, discretionary, and healthcare.

While Shenzhen stocks are thematically compelling and generally offer high EPS growth
(28% for 2016E), they are more speculative (5.7x ann. velocity, 66% owned by retail
investors), more expensively valued (29X fP/E vs. 14X in SH), and are not well-covered by
sell-side brokers. As such, we believe investors will need to be selective when investing
in the Shenzhen bourse.

28

2015 12 3

Exhibit 63: The extension of the Connect scheme to

Shenzhen will create a unified China market, which will
nd
be the 2 largest globally
(US$ tn)
20

Market cap

# of listed companies (RHS)

5000
4000

15

Exhibit 64: Shenzhen vs. Shanghai: Different value

propositions; different strategies
'New China' weight
30%
24%
20%

13%

3000

10%

10
2000

Note: Based on WFE compiled data, as of Oct 2015.

Singapore

Taiwan

Korea SE

Australian SE

Deutsche Brse

SZSE

Hong Kong SE

Euronext

Japan SE

London SE

NASQAD

SHSE + SZSE

NYSE

1000

China + HK

0%
Shenzhen

Fwd 12M P/E (x)

29
30

Retail ownership
70%
66%

25

60%
47%

50%
40%

20
14

15
10

Shenzhen
Source: WFE.

Shanghai

Turnover velocity (x)

5.7
6.0
5.5
5.0
4.5
4.1
4.0
3.5
Shenzhen
Shanghai

Shanghai

Shenzhen

Shanghai

Source: Bloomberg, FactSet, Wind, Goldman Sachs Global Investment

Research.

4. Potential A-share inclusion to MSCI (timing: May 2016)

Post the confirmation of the inclusion of ADRs to MSCI benchmarks, the next important
inclusion event which we expect will gather global investors attention would be the
potential inclusion of A shares to the MSCI universe. The decision announcement is
scheduled on May 12, 2016, as a part of MSCIs semi-annual index review.

Our base case hasnt changed despite the ups and downs in the A-share market: SZ-HK
Connect is the most important pre-condition for this to materialize as it would complete
foreign investors accessibility requirement by the MSCI. As of now, international investors
cant freely trade Shenzhen-listed stocks unless they are granted QFII capacity, which is
subject to stringent approval processes.

Besides the accessibility issue, the international investment community is also concerned
about the protection of investor interests, freedom to transact (especially in
tumultuous times when liquidity premium usually escalates), availability of hedging tools,
and other operational issues (e.g. program trading), and much more so after the
interventions by the government during the summer correction.

All in all, assuming Shenzhen Connect starts trading in 2Q16, we believe including A shares
to MSCI in 2016 remains a possibility if regulators can make enough progress to
improve market structure and align trading rules with global practices. If our expectation
prevails, we estimate that China could represent 29% of MXEF on 10% A-share
inclusion, and 41% on full-market-cap inclusion by mid-2017.

29

2015 12 3

Exhibit 65: We expect China to represent 1/3 of EMs and

APJs investors benchmark in 2 years

Number of stocks

900

Suspension due to
important events

600

Note: China ADR includes 14 ADRs to be added into MSCI China index as
announced by MSCI; China A is MSCI China A international index; Proforma weight is calculated by dividing the index market cap to be added by
the combined index market cap.
Source: MSCI, FactSet, Goldman Sachs Global Investment Research.

71%
28%

Nov-15

MXAPJ

Oct-15

MXEM

300

Sep-15

MSCI China

0%

Aug-15

10%

87% of stocks
suspended due
to important
events

Jul-15

China ADR

Suspension due to
restructuring

1200

Jun-15

20%

4.0%2.2%
21%

May-15

22%

2.3%
4.4%

1500

Jan-15

30%

China A
(IF=10%)

11% of stocks
suspended due
to restructuring

Suspension due to other

reasons

Apr-15

39%

40%

1800

Mar-15

41%

China all
(IF=100%)

Feb-15

Pro-forma weight in indexes

50%

Exhibit 66: Number of suspended stocks has fallen

significantly since the July peak, and stocks which are
now suspended seem to be backed by valid reasons,
rather than important events

Source: Wind.

5. The maiden year of the 13th FYP; (timing: over the course of 2016)

This is the first FYP by the current administration and has significant strategic
/economic importance given the decelerating (potential) growth trajectory and the ongoing
shifts of growth composition in the economy.

While the plan is still subject to further refinements and the final approval from the NPC in
th
March 2016, the initial guideline published after the 5 Plenum points to an overarching
objective of promoting balanced and sustainable growth, with internal and external
coordination (e.g. Jing-jin-ji and 1 belt 1 road), reforms (SOEs, opening up of service sectors),
technology adoption (internet services, high-tech manufacturing), and improvement of
environmental and social issues being the key focus areas.

Generally, the policy bias is favorably skewed towards the New China economy,
while SOE reforms could create potential beneficiaries but also further stresses for the Old
China segment, in our view.

30

2015 12 3

Exhibit 67: The 13th 5-year plan will likely focus on the following key strategic and socioeconomic issues
Key themes of the 13th five-year plan
Main Themes

Related Sectors

Key objectives
Creating new demand and promoting new technology
Expanding infrastructure construction

Potential Winners

Developing economy with information technology

Big data, cloud computing, "Internet+"

Promoting agricultural standardization and information sharing

Agricultural machinery, distribution chain of

agricultural products

Implementing manufacturing with intelligence technology

High-end CNC machines, robotics

Accelerating development of modern service industry

Tourism

SOE reform

SOE mixed ownership reform, State-owned capital

investment and operation companies

Innovation

Potential Losers

Energy saving and environmental protection,

biotech, technology companies
Information infrastructure, pipe network,
water/sewage system

Industries with excess capacity, i.e. iron and

steel, cement, chemicals, coal, etc.

Price deregulation
Promoting urbanization

Cooperation

Education, healthcare, mass consumption

Promoting civil military integration

Promoting Jing-Jin-Ji development

Accelerating development of wind power, solar power, biomass

Wind power, solar power industries, etc.
energy, hydro power and geothermal energy

Developing nuclear power and smart grid construction

Green
development

Opening-up

High-end equipment manufacturing, new materials,

aerospace and marine engineering equipment
Regional real estate, building materials,
High-pollution industries in the region
infrastructure construction

Promoting green buildings and building materials

Nuclear equipment, smart grid

Coal, oil
Coal, oil

'New' building materials

Implementing environmental prevention plans on air, water and

Environmental protection related industries
soil pollutions
Strengthening governance of energy consumption of energy
intensive industries
Autos/tech supply chain focusing on new energy
Promoting adoption of new energy automobiles
vehicles
Local companies located in Guangzhou, Shenzhen,
Developing Free Trade Zones (FTZs)
Hengqin, Tianjin, Fujian

Achieving capital account convertibility in an orderly manner

Financials

Promoting "One Belt, One Road" projects

High-speed railway, construction

Chemicals, iron and steel, etc.

Electric power, iron and steel, building
materials, chemicals
Traditional automobiles

Promoting construction of Economic Zone at Western Bank of

Fujian related stocks, Pingtan Experimental Zone
Taiwan Straits
Supporting Hong Kong to strengthen the role as global offshore

HK banks, brokers, and exchange operator

RMB business hub

Supporting Macau to build a world tourism and leisure center

Entertainment business/casino operators in Macau

Establishing a more equal and sustainable social security system Mass consumption, education, healthcare
Liberalizing investment channels for Social Security Funds

Listed blue-chip companies with high/stable

dividend yields

Opening up the hospital industry

Private hospitals

Social welfare
More efforts to be made on improving poverty
Universal two-child policy
'Healthy China'

Infrastructure of rural areas, mass consumption,

education
Infant-related consumption, entertainment,
healthcare, education
Mobile health care, elderly care industry

Source: Xinhua News, Goldman Sachs Global Investment Research.

6. Intensity of the anticorruption campaign (timing: over the course

of 2016)

rd

The anticorruption campaign has been gathering investors attention since the 3 Plenum
when it was profiled as one of the key policy objectives by the current administration. Indeed,
rd
since the 3 Plenum, the intensity of the campaign has been kept at high levels,
proxied by the number of senior officials (deputy ministerial level or above) who have
undergone disciplinary investigations. This is one of the key reasons for our subdued macro
growth forecast for 1Q16, during which Chinese New Year related entertainment could be
disproportionately impacted by the campaign.

31

2015 12 3

While we expect the anticorruption drive to be here to stay and indeed be a part of the new
normal growth profile for political and social reasons, certain sectors, such as Energy and

Telecoms, are arguably in a more mature cycle in terms of number of corruption

charges received, in our view.

This observation also supports our view that the sectors which have been impacted by
anticorruption could be more incentivized to push through SOE reforms as the interest
and incentive between the government and SOE management could be better aligned, all
else equal.

Exhibit 68: After a temporary fall in early 3Q, anticorruption intensity seems to have picked
up again

Number of senior officials (deputy ministerial level or above)

officially announced to be under investigation
10
18th CPC
Third Plenum

8
6
4
2

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

Jul-09

Jan-09

Source: CCDI, Goldman Sachs Global Investment Research.

Exhibit 69: Energy and Telecoms have seen relatively more corruption charges than other
SOE sectors
Sector

2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

Conglomerates
Cons. Disc.
Energy
Financials
Industrials
IT
Materials
Telecom
Utilities

0
0
0
1
0
0
0
0
0

0
0
1
0
0
0
0
1
0

0
0
0
0
0
0
1
1
0

0
0
1
0
0
0
0
3
0

1
1
1
0
5
0
1
1
0

1
1
0
0
0
1
1
0
0

2
3
3
0
0
0
1
2
1

1
1
3
0
4
1
3
0
3

2
0
2
0
3
0
1
3
1

2
3
3
1
0
0
1
0
0

0
2
0
0
1
0
1
0
0

Total

10

12

16

12

10

Total

9
11
14
2
13
2
10
11
5
77

Note: We collect all the investigation announcements (over 1300) on the CCDI website from May 2013 to Nov 2015, and
aggregate the number of managers of listed companies or conglomerates with listed companies, being investigated in each
quarter.
Source: CCDI, Goldman Sachs Global Investment Research.

32

2015 12 3

#11: ThemesNew China leaders; Old China revengers; Rmb

hedges
a) New China leaders

In our recent report: China Strategy: New China investing in a new normal growth era, Nov
6, we argued that investors need to embrace a new framework when investing in
Chinese equities given the ongoing macro and micro changes that are manifesting in the
economy. These evolutions have led to significant return divergence among widelyfollowed Chinese equity indexes, and also at the stock level.

In sum, we like New China stocks on a structural growth basis (e.g. in 1H15, New China
generated 35% revenue growth vs. 0% for Old China), and this secular view is reinforced by
cyclical considerations including:
1.

Our macro expectations of slower growth but still-easy financial conditions are
historically supportive of the outperformance for New vs. Old China;

2.

Year-to-dated earnings revision trends remain resilient for New China while
Old China earnings have been revised down 13% ytd;

3.

While New China is trading at 27x forward earnings (13x for Old China), its

valuation premium would look less discomforting when benchmarked

against its earnings growth potentialits trading on 1.2X PEG, a 20% premium
over Old China, vs 26% average in the past 5 years.
Our analysis shows that GEM investors are currently underweight China by
283bps and over 711bps on a pro-forma basis (post the full inclusion of ADRs). By
sector, GEM funds are effectively underweight the China IT sector (in an EM context)
by close to 400bps on a pro-forma basis (end May 2016). This leads us to believe
that New China stocks are a sensible vehicle for investors to close this gap,
considering light positioning and strong fundamentals.

4.

Exhibit 78 shows a list of New China stocks under our coverage, listed in both the
onshore and offshore markets, averaging 23x 2016P/E and 26% 2015-2017 EPS CAGR.
Exhibit 71: Return variances have been high in both
offshore and onshore markets, partly reflecting the
divergent fundamental trends among various economic
groups

Exhibit 70: Chinese equity indexes have delivered

markedly different returns

Return decomposition, past 3 years

338%

350%

300%

200%

Forward P/E % change

Source: FactSet, MSCI, I/B/E/S, Goldman Sachs Global Investment Research.

0%
-50%
-1SD: -29%

Nov-15

Aug-15

Feb-15

May-15

Nov-14

Aug-14

Feb-14

May-14

-100%

Nov-13

HSCEI

HSI

MXCN

AC World

A50

CSI 300

SHCOMP

CN ADRs

SZCOMP

Chinext

-50%

Aug-13

0%
-6%

Feb-13

0%
-50%

24%

50%

2%

May-13

2%

Nov-12

23%

50%

Aug-12

50%

100%
47%

Feb-12

68%

May-12

75%

+1SD: 76%

100%

150%

120%

100%

MSCI All China Index

Nov-11

150%

150%

Aug-11

200%

250%

Forward EPS % change

192%

Index Constituent Return (+/- 1SD)

300%

Price Performance (US$)

250%

Rolling12M Returns
200%

May-11

350%

Source: FactSet, MSCI.

33

2015 12 3

Exhibit 72: New China managed to grow earnings in

1H15 vs. 7% of Old China even in a slowing growth
environment

Exhibit 73: Our macro expectations suggest New China

should outperform Old China

Earnings growth (yoy)

120%
100%
80%
60%
40%
20%

New China relative performance (vs. Old China) model

Constant
0.02
R-squared
0.69
LIQUIDITY
-0.50
Adjusted R-squared
0.66
GROWTH
-0.21

Source: Bloomberg, Wind, Goldman Sachs Global Investment Research.

Source: CEIC, Bloomberg, Goldman Sachs Global Investment Research.

Exhibit 74: Earnings revisions stay robust for New China

Exhibit 75: In terms of valuations, New China isnt

trading at a significant premium over Old China

Jun-15

Jan-15

Aug-14

Mar-14

Oct-13

May-13

Jul-12

Dec-12

Feb-12

Sep-11

Nov-15

Oct-15

Sep-15

Aug-15

Jul-15

Jun-15

May-15

Apr-15

Mar-15

Feb-15

Jan-15

Dec-14

85

Apr-11

Old China

90

Nov-10

95

Jan-10

New China

100

Market cap-weighted f-PEG (x)

Difference (%)
60%
1.3
1.2
New China premium - RHS
1.2
50%
New China
1.1
Old China
40%
1.0
0.9
30%
1.0
0.8
20%
0.7
10%
0.6
0.5
0%

Jun-10

Earnings revision, 2015&16 average

105

Source: Bloomberg, Wind, Goldman Sachs Global Investment Research.

Source: Bloomberg, FactSet, Wind, Goldman Sachs Global Investment

Research.

Exhibit 76: GEM investors are currently underweight

China by 300bps and over 700bps on a pro-forma basis

Exhibit 77: GEM funds are underweight China tech by

close to 300bps on a forward basis
China Holdings of EM Active managers
Overweight
73

49

Marketweight
17 22

9 12

Hong Kong

100
-100

(Off-benchmark allocation)

-200

-283

Underweight

3 5

-31

-56 -44 -74 -68

-200
-300

Note: As of Oct 2015.

Source: EPFR, MSCI, Goldman Sachs Global Investment Research.

Utilities

Industrials

Health Care

-600

Materials

Note (1): Overall GEM mutual funds AUM ~ US$205bn

Note (2): Based on EPFR survey data for GEM funds vs. MSCI EM benchmark

-500

Cons. Stap.

-711

Oct-14

Oct-13

Oct-12

Oct-10

Oct-09

Oct-08

Oct-07

Oct-06

Oct-05

-800

Oct-11

Pro-forma China UW
after ADR inclusions

-388 EM funds China allocation

(OW/UW, bp)
China
Pro-forma China

Cons. Disc.

-600

-400

IT

China Offhsore
(excl. HK)

Oct-15

-400

-102

-87

-108 -97

Based on Top 200

EM funds (AUM:
US$ 320 bn); as of
Aug 2015

-565

-507

Financials

194

200

Telecom

China/HK allocation in GEM mutual funds (OW/UW)

Energy

bp
400

Sep-15

May-15

Jan-15

Sep-14

May-14

Jan-14

Sep-13

May-13

Jan-13

Sep-12

Jan-12

1H15

2014

2013

2012

2011

2010

2009

2008

2007

2006

7%

May-12

0%
-20%
-40%

Residual of model
Model estimates
New China relative performance (over Old China)

100%
80%
60%
40%
20%
0%
-20%
-40%

Sep-11

47%

May-11

Old China

Jan-11

New China

Note: As of Aug 2015.

Source: FactSet, Lionshare, MSCI, Goldman Sachs Global Investment

Research.

34

2015 12 3

Exhibit 78: Based on our screening criteria, these stocks offer strong growth at reasonable valuations in our New
China universe
'New China' Sector

Ticker

Company name

Sector

New China (onshore)

600196 CG Fosun Pharma
600535 CG Tasly Pharma
002415 CS Hikvision Digital Tech
601318 CG Ping An Insurance
300070 CS OriginWater
000826 CS Tus-Sound Environment
New China (offshore)
700 HK
Tencent
2357 HK
AviChina
VIPS UN
Vipshop
BABA UN
Alibaba
XRS UN
TAL Education
BIDU UW
Baidu
NTES UW
NetEase
371 HK
Beijing Enterprises Water

>1000

Quoted
Price

>10

>10%

Listed
3M
15-17E
market
ADVT
EPSg
cap
(US$mn)
(%)
(US$mn)

<=1.5
15E
PEG
(X)

B/B*
15E
P/E
(X)

16E
P/E
(X)

15E
P/B
(X)

GS
Rating

Potential
upside
(%)

Health Care
Health Care
IT
Financials
Industrials
Utilities
Average

CNY
CNY
CNY
CNY
CNY
CNY

24.5
36.1
33.8
34.1
50.0
38.1

7,301
6,094
21,474
57,764
9,607
5,042
17,880

77
32
132
479
39
58
136

20
20
35
11
37
35
26

1.2
1.2
0.6
1.0
1.1
0.8
1.0

23.7
24.3
21.4
11.3
41.0
28.7
25.1

19.9
20.3
15.4
10.4
27.6
20.5
19.0

3.1
6.3
6.9
1.8
6.8
5.2
5.0

B*
B
B*
B*
B
B

60%
55%
39%
24%
4%
3%
31%

IT
Industrials
Cons Disc
IT
Cons Disc
IT
IT
Utilities
Average

HKD 154.3
HKD
6.7
USD 16.2
USD 84.0
USD 43.6
USD 214.1
USD 164.4
HKD
6.1

187,120
2,043
8,105
195,445
1,926
59,123
21,636
6,864
60,283

304
13
211
1,491
23
799
144
12
375

26
27
35
23
27
32
16
21
26

1.5
1.3
0.8
1.4
1.3
1.3
1.3
1.1
1.3

38.8
36.2
29.3
32.8
34.4
42.3
21.1
22.8
32.2

30.1
27.1
21.9
26.9
28.4
33.1
17.5
18.4
25.4

10.9
2.6
13.7
6.6
8.8
7.5
4.8
3.1
7.2

B*
B
B
B
B
B
B
B

31%
26%
23%
21%
19%
16%
16%
13%
21%

Note: B=Buy; * Denotes stocks on the Conviction List; Pricing as of Dec 1.

Source: FactSet, I/B/E/S, Goldman Sachs Global Investment Research.

b) Old China revengers

While our strategic bias favors New China, it doesnt prevent us from engaging in Old China,
especially at times when equity valuations are depressed, profitability expectations are low, and
specific themes/stories and potential cyclical recovery are inexpensively priced. These conditions
tend to offer good risk/reward to trade Old China. In this vein, we highlight two top-down angles
that we view as important for picking stocks in Old China.

SOE reforms: We expect the 2nd round of central SOE reform to be launched and more
local SOE restructuring efforts to be made in 2016. While the immediate fundamental
impacts are always difficult to estimate, most SOE restructuring announcements have
tended to result in positive market reactions. See China Strategy: The case for rerating (Part 1): Top-down drivers and path, March 4.

Bottomed out stocks with improving story: Exhibit 80 shows that Old China sectors
are not only generally experiencing operating challenges, their equity valuations are also
being priced at significant discounts to their long-term averages (lower left quadrant). We
fully acknowledge that profitability normalization may not universally apply to all these sectors
when the macro story for China is changing, but we see positive fundamental delta
developing in, for example, Property (further recovery of the housing market), Energy
(stabilization of oil prices) in anticorruption), and Telecoms (better 4G adoption, lower capex).

In Exhibit 81, we screen for Buy-rated stocks which belong to sectors where current valuations
and profitability (ROE) are meaningfully below their respective long-term averages. This filters out
Banks, Energy, F&B, Real Estate, and Telecoms. And for Energy and Telecoms, they also
fit into our view that a more mature anticorruption cycle in these sectors could potentially lead to
more decisive SOE reforms.

35

2015 12 3

Exhibit 79: Some SOE restructuring announcements have resulted in positive market
reactions
Announcement date

Reform actions

Companies /
sectors of impact

2014-3-25

CITIC parentco to inject assets into listco

CITIC Pacific

2014-4-29

Centralize the telecoms' base stations

Mixed ownership pilot program for 6
SOEs
Asset spinoffs by PetroChina and
Sinopec
Railway sector consolidation
Cut the pay of executives at centrally
administered SOEs
'one belt and one road' strategy
Bank of Communications mixedownership reform
COSCO, CSCL, CSD and other group
related stocks suspended trading on
potential restructuring.
AVIC asset restructuring
PetroChina pipeline and gas storage
assets restructuring

2014-7-15
2014-8-4
2014-9-4
2014-9-25
2014-11-12
2015-6-16
2015-8-10
2015-8-18
2015-11-26

Relative performance
Onshore
Offshore
+1M +3M +6M +1M +3M +6M
-

7%

2%

0%

Telecom

2%

4%

1%

-1%

-2%

2%

6 SOEs

2%

8%

17%

-5%

-6%

-6%

Oil SOEs

2%

-5%

-8%

0%

7%

4%

Railway SOEs

3%

40% 65%

6%

17% 28%

Central SOEs

Industrials

-1%

0%

3%

2%

BoComm

11%

6%

1%

0%

-6% -10%

Shipping

AVIC group
PetroChina

Average
Median

-24% -15% -19% -9%

-1%
2%

0%

5%

5%
4%

9%
1%

0%
0%

2%
1%

3%
2%

Source: Xinhua News, Sina News, SASAC, NDRC.

Exhibit 80: Some of the Old China sectors are trading at low valuations and low
profitability expectations

3.5

Old China
New China

3.0

Commercial Services

P/B z-score (10Y)

2.5

Tech Hardware

Software & Services

Media

2.0

Pharmaceuticals

Semiconductors
Consumer Durables
Health Care Services
Capital Goods
Consumer Services
Household Products
Retailing
Autos
Utilities
Transportation
Materials
Real Estate
Diversified Financials
Food & Beverage
Energy
Insurance
Banks
Telecom

1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

ROE z-score (10Y)

Note: this is based on aggregate China, and is grouped based on GICS2 industry group classification; ROE and P/B are
calculated using end-2014 numbers.
Source: FactSet, Goldman Sachs Global Investment Research.

36

2015 12 3

Exhibit 81: Old China stocks which fall under Banks, Energy, F&B, Real Estate, and Telecoms, and are rated Buy by
our analysts
'Old China' Sector

Ticker

Company name

Sector

Old China (onshore)

600519 CG Kweichow Moutai
002304 CS Yanghe Brewery
000858 CS Wuliangye Yibin
600340 CG China Fortune Land
601288 CG Agricultural Bank of China
000002 CS China Vanke
000001 CS Ping An Bank
601939 CG China Construction Bank
600048 CG Poly Real Estate

Cons Stap
Cons Stap
Cons Stap
Financials
Financials
Financials
Financials
Financials
Financials
Average

Quoted
Price

CNY 213.8
CNY 65.0
CNY 24.8
CNY 27.2
CNY
3.1
CNY 16.6
CNY 11.8
CNY
5.7
CNY 10.6

Old China (offshore)

813 HK
Shimao Property
998 HK
China Citic Bank
1288 HK
Agricultural Bank of China
Dalian Wanda
939 HK
China Construction Bank
322 HK
Tingyi
1918 HK
Sunac
688 HK
China Overseas Land
941 HK
China Mobile
1088 HK
Shenhua Energy
857 HK
PetroChina

>1000

>10

<=2.0

Listed
15-17E
3M
market
EPSg
ADVT
cap
(%)
(US$mn)
(US$mn)
41,974
15,309
14,707
11,239
143,383
25,220
26,276
8,516
17,750
33,819

Financials
HKD 13.5
6,065
Financials
HKD
4.9
9,483
Financials
HKD
3.0
11,895
Financials
HKD 48.3
4,066
Financials
HKD
5.4 166,842
Cons Stap
HKD 11.3
8,181
Financials
HKD
5.6
2,447
Financials
HKD 27.4
34,787
Telecom
HKD 90.4 238,757
Energy
HKD 12.5
5,471
Energy
HKD
5.7
15,377
Average
45,761
Note: B=Buy, N=Neutral; * Denotes stocks on the Conviction List; Pricing as of Dec 1.

15E
PEG
(X)

B/B*
15E
P/E
(X)

16E
P/E
(X)

15E
P/B
(X)

GS
Rating

>10%
Potential
upside
(%)

75
53
136
118
352
133
117
199
273
162

10
17
12
25
4
15
12
4
12
12

1.6
1.2
1.4
0.6
1.3
0.7
0.6
1.5
0.7
1.0

16.2
19.1
15.8
14.4
5.7
10.1
7.3
6.2
7.8
11.4

14.7
16.5
14.0
11.5
5.6
8.7
6.6
6.0
6.8
10.0

4.1
4.3
2.2
5.3
0.8
1.8
1.1
0.9
1.3
2.4

B*
B
B
B
B
B
B
B
B

42%
40%
31%
28%
25%
18%
16%
16%
16%
26%

13
36
63
32
230
13
11
75
208
35
87
73

6
5
2
18
2
13
16
13
4
2
34
11

0.5
0.6
0.9
0.5
1.1
1.6
0.2
0.7
1.9
1.9
0.5
0.9

4.7
4.6
4.4
10.1
4.8
20.9
4.3
8.7
13.0
8.9
17.2
9.2

4.4
4.5
4.4
8.4
4.8
18.3
3.7
7.7
12.5
9.2
14.3
8.4

0.7
0.6
0.7
1.0
0.7
2.4
0.7
1.2
1.6
0.7
0.7
1.0

B*
B*
B
B
B
B
B
B
B*
B
B

75%
60%
57%
47%
43%
42%
42%
37%
32%
27%
22%
44%

Source: FactSet, I/B/E/S, Goldman Sachs Global Investment Research.

c) Equity hedges on Rmb weakness

To express our view that there could be non-trivial risks for a one-off Rmb devaluation and to
position for the potential market ramifications, besides options strategy, we highlight a group of
stocks which may fundamentally benefit in a Rmb depreciation scenario based on our
analysts bottom-up estimates.
In a similar vein, we have put together a list of companies which may lose out when the currency
weakens. The relative performance of the two lists seems to have mirrored the Rmb movement
quite closely since the Aug 11 devaluation.
In fundamental terms, every 10% Rmb depreciation (vs. the USD) could on average
boost/reduce 2015 earnings by 41%/81% for the beneficiaries/losers group, respectively.

37

2015 12 3

Exhibit 82: The relative performance between stocks which may benefit and lose out in a
Rmb weakening environment seems to mirror the actual Rmb movement

Indexed price performance

140

CNYUSD
6.45

RMB depreciation winners

relative to losers

130

6.40

CNYUSD spot

6.35

120
6.30

Rmb
depreciation

110

6.25

Nov-15

Oct-15

Sep-15

Sep-15

Aug-15

Jul-15

Jul-15

Jun-15

May-15

May-15

Apr-15

Mar-15

Mar-15

6.15

Feb-15

90

Jan-15

6.20

Dec-14

100

Source: Bloomberg, Goldman Sachs Global Investment Research.

Exhibit 83: These stocks may disproportionately benefit or lose out in a Rmb weakening environment, based on our
analysts estimates

Ticker

Company name

Sector

Stocks with highest negative earnings sensitivity

323 HK
Maanshan Iron & Steel
Materials
600031 CH
Sany Heavy
Industrials
000800 CS
FAW Car
Cons Disc
881 HK
Zhongsheng Group
Cons Disc
119 HK
Poly Property Group
Financials
3339 HK
Lonking Holdings
Industrials
2899 HK
Zijin Mining
Materials
1728 HK
Zhengtong Auto
Cons Disc
1157 HK
Zoomlion
Industrials
410 HK
SOHO China
Financials
1112 HK
Biostime Int'l
Cons Stap
392 HK
Beijing Enterprises
Industrials
1293 HK
Baoxin Auto Group
Cons Disc
1193 HK
China Resources Gas
Utilities
2039 HK
China Int'l Marine Containers
Industrials
Average
Stocks with highest positive earnings sensitivity
1818 HK
Zhaojin Mining
Materials
601717 CH
Zhengzhou Coal Mining MachineryIndustrials
763 HK
ZTE Corp. (H)
IT
TSL UN
Trina Solar
IT
631 HK
Sany Heavy Equipment Intl.
Industrials
1378 HK
China Hongqiao Group
Materials
958 HK
Huaneng Renewables
Utilities
6837 HK
Haitong Securities
Financials
600418 CG
Anhui Jianghuai Auto
Cons Stap
2313 HK
Shenzhou International
Cons Stap
1829 HK
China Machinery Engineering CorpIndustrials
358 HK
Jiangxi Copper
Materials
347 HK
Angang Steel
Materials
000768 CH
AVIC Aircraft
Industrials
3993 HK
China Molybdenum
Materials
2386 HK
Sinopec Engineering Group
Industrials
Average

Listed
3M ADVT
Quoted Price market cap
(US$mn)
(US$mn)

Net income
change for
10% Rmb
depreciation

16E
EPSg
(%)

17E
EPSg
(%)

15-17E
15E
EPSg
PEG (X)
(%)

15E
P/E
(X)

16E
P/E
(X)

15E
P/B
(X)

GS
Potential
Rating upside (%)

HKD
CNY
CNY
HKD
HKD
HKD
HKD
HKD
HKD
HKD
HKD
HKD
HKD
HKD
HKD

1.6
6.5
14.8
3.8
2.5
1.3
2.0
3.2
3.0
3.3
13.1
47.9
3.3
21.8
13.6

367
7,678
3,764
1,058
1,200
718
1,459
915
541
2,220
1,065
7,918
1,072
6,254
2,509
2,582

2
102
75
2
5
1
8
3
2
6
6
14
3
9
2
16

-189%
-183%
-84%
-82%
-75%
-71%
-64%
-62%
-57%
-57%
-49%
-47%
-47%
-44%
-41%
-77%

700
17
20
52
19
16
23
10
24
16
14
15
12
72

489
10
5
23
58
26
26
14
60
13
18
9
15
10
11
53

197
11
21
55
23
21
18
12
21
13
15
12
11
33

3.3
4.2
0.4
0.6
0.8
0.8
0.4
2.0
0.6
0.8
0.5
1.3
1.0
1.3

645.0
45.5
9.4
32.2
18.4
15.9
7.6
23.5
13.3
10.9
8.0
16.2
10.8
65.9

137.0
80.6
38.9
7.8
21.2
15.5
13.6
6.2
72.1
21.3
10.7
9.3
7.0
14.1
9.7
31.0

0.5
2.1
2.6
0.6
0.3
0.7
1.2
0.7
0.5
0.4
2.1
1.0
1.2
2.6
1.2
1.2

S
S
S
S
N
N
N
B
N
N
N
B*
N
B
N

-39%
-46%
-44%
-35%
14%
8%
-8%
34%
-1%
24%
40%
34%
3%
16%
8%
1%

HKD
CNY
HKD
USD
HKD
HKD
HKD
HKD
CNY
HKD
HKD
HKD
HKD
CNY
HKD
HKD

4.2
6.9
17.7
9.8
1.7
3.8
2.4
13.6
14.9
41.1
6.1
9.3
3.1
24.5
1.6
6.1

474
1,477
1,725
905
663
3,138
1,298
5,973
3,405
7,417
711
1,657
434
10,601
797
1,148
2,614

2
28
11
20
0
5
9
45
104
13
3
14
4
232
3
2
31

87%
74%
58%
56%
45%
44%
40%
40%
37%
33%
31%
29%
19%
19%
16%
13%
40%

7
55
13
107
126
11
18
-11
41
13
9
19
47
6
-1
31

12
41
10
2
8
11
19
8
19
13
18
5
60
41
21
5

10
48
11
45
56
11
19
-2
30
13
13
11
44
14
2
22

2.3
1.5
1.4
0.3
0.8
0.3
0.5
-4.3
0.6
1.5
0.8
1.3
3.7
1.5
2.9
1.0

22.7
70.0
16.1
15.3
45.6
3.8
10.2
8.4
18.9
19.7
10.2
15.1
163.3
20.5
6.7
29.8

21.1
45.1
14.3
7.4
20.2
3.4
8.6
9.5
13.4
17.4
9.4
12.8
32.4
111.4
19.3
6.7
22.0

1.1
1.2
2.0
0.8
0.7
0.5
1.1
1.2
2.6
3.6
1.4
0.6
0.4
4.5
0.4
0.9
1.4

N
N
N
B
S
B
N
B
N
B
B
N
N
S
N
B

-14%
-4%
-7%
22%
1%
34%
8%
34%
-22%
11%
57%
10%
6%
-27%
-19%
72%
10%

Note (1): Earnings impacts on RMB depreciation are based on GS analysts' estimates.
Note (2): B = Buy, N = Neutral, S= Sell, * denotes stocks on the Conviction list; Prices as of Dec 1.
Source: FactSet, I/B/E/S, Gao Hua Investment Research, Goldman Sachs Global Investment Research.

38

2015 12 3

#12: Stock ideas20 top picks for 2016

Aggregating our macro expectations, equity market forecasts, thematic preferences, and our
analysts bottom-up fundamental views, we highlight 20 names (10 each for the offshore and
onshore markets) which we view as stocks which should be part of investors core holdings
in 2016.
On average, they offer 21% 15-17 EPS CAGR, trade on 19x 2016 P/E and 1.2x PEG, and have
31% 12m potential upside relative to our analysts target prices.
Exhibit 84: These 20 names collectively express our macro, micro, and thematic views

Ticker

Company name

Top-10 picks (onshore)

600196 CG Fosun Pharma
600535 CG Tasly Pharma
600519 CG Kweichow Moutai
002415 CS Hangzhou Hikvision
002008 CS Han's Laser Tech
300124 CS Inovance Tech
600340 CG China Fortune Land
601318 CG Ping An Insurance
601098 CG China South Publishing
000002 CS China Vanke
Top-10 picks (offshore)
688 HK
China Overseas Land
392 HK
Beijing Enterprises
941 HK
China Mobile Limited
700 HK
Tencent
2357 HK
AviChina
2186 HK
LUYE Pharma
VIPS UN
Vipshop
BABA UN
Alibaba
BIDU UW
Baidu
2313 HK
Shenzhou Int'l

Listed
3M
15-17E
market
ADVT
EPSg
cap
(US$mn)
(%)
(US$mn)

Quoted
Price

Sector

Health Care
Health Care
Cons Stap
IT
Industrials
Industrials
Financials
Financials
Cons Disc
Financials

CNY 24.5
CNY 36.1
CNY 213.8
CNY 33.8
CNY 24.0
CNY 44.2
CNY 27.2
CNY 34.1
CNY 24.3
CNY 16.6

7,301
6,094
41,974
21,474
3,961
5,467
11,239
57,764
6,832
25,220

Financials
HKD 27.4
34,787
Industrials
HKD 47.9
7,918
Telecom
HKD 90.4 238,757
IT
HKD 154.3 187,120
Industrials
HKD
6.7
2,043
Health Care
HKD
7.0
2,999
Cons Disc
USD 16.2
8,105
IT
USD 84.0 195,445
IT
USD 214.1
59,123
Cons Disc
HKD 41.1
7,417
Average
46,552
Note: B=Buy; * Denotes stocks on the Conviction List; Pricing as of Dec 1.

15E
PEG
(X)

15E
P/E
(X)

16E
P/E
(X)

15E
P/B
(X)

GS
Rating

Potential
upside
(%)

77
32
75
132
100
99
60
479
32
133

20
20
10
35
27
24
25
11
22
15

1.2
1.2
1.6
0.6
1.3
1.8
0.6
1.0
1.1
0.7

23.7
24.3
16.2
21.4
34.2
41.9
14.4
11.3
24.1
10.1

19.9
20.3
14.7
15.4
24.6
32.6
11.5
10.4
19.4
8.7

3.1
6.3
4.1
6.9
5.4
7.6
5.3
1.8
3.7
1.8

B*
B
B*
B*
B*
B
B
B*
B*
B

60%
55%
42%
39%
35%
32%
28%
24%
20%
18%

70
14
208
304
13
5
211
1,491
799
13
217

13
13
4
26
27
19
35
23
32
13
21

0.7
0.8
1.9
1.5
1.3
1.2
0.8
1.4
1.3
1.5
1.2

8.7
10.9
13.0
38.8
36.2
23.5
29.3
32.8
42.3
19.7
23.8

7.7
9.3
12.5
30.1
27.1
19.6
21.9
26.9
33.1
17.4
19.2

1.3
1.0
1.6
10.9
2.6
3.4
13.7
6.6
7.5
3.6
4.9

B
B*
B*
B*
B
B*
B
B
B
B

37%
34%
32%
31%
26%
26%
23%
21%
16%
11%
31%

Source: FactSet, I/B/E/S, Gao Hua Securities Research, Goldman Sachs Global Investment Research.

Exhibit 85: These 20 names have done well so far in 2015

and we expect they will further outperform next year

Exhibit 86: Forward earnings have been strong for these

20 companies

YTD price performance

150
Top-20 picks
140

f-P/E (x)
26

Nov-15

Oct-15

Sep-15

Jan-15

Dec-14

Nov-15

Oct-15

Sep-15

Aug-15

Jul-15

Jun-15

May-15

Apr-15

Mar-15

Feb-15

Jan-15

Dec-14

Source: FactSet, I/B/E/S, Goldman Sachs Global Investment Research.

16

Aug-15

18

90

Jul-15

100

20

Jun-15

+1%

May-15

110

22

Apr-15

+21%

120

Mar-15

24

130

Feb-15

MSCI All China index

f-EPS integer (indexed to 100)

114
112
113
110
108
106
104
102
Average fP/E
19.2 100
f-EPS integer - RHS
98

Source: FactSet, I/B/E/S, Goldman Sachs Global Investment Research.

39

2015 12 3

Gao Hua Securities acknowledges the role of Kinger Lau, CFA, Timothy Moe, CFA, Jack Wang,
Si Fu, Ph.D., Ki Cheong Wong, Ph.D. and Alvin So of Goldman Sachs in the preparation of this
product.

Special disclosure
All MSCI data used in this report is the exclusive property of MSCI, Inc. (MSCI). Without prior
written permission of MSCI, this information and any other MSCI intellectual property may not be
reproduced or redisseminated in any form and may not be used to create any financial
instruments or products or any indices. This information is provided on an as is basis, and the
user of this information assumes the entire risk of any use made of this information. Neither MSCI,
any of its affiliates nor any third party involved in, or related to, computing or compiling the data
makes any express or implied warranties or representations with respect to this information (or
the results to be obtained by the use thereof), and MSCI, its affiliates and any such third party
hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or
fitness for a particular purpose with respect to any of this information. Without limiting any of the
foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to,
computing or compiling the data have any liability for any direct, indirect, special, punitive,
consequential or any other damages (including lost profits) even if notified of the possibility of
such damages. MSCI and the MSCI indexes are service marks of MSCI and its affiliates. The
Global Industry Classification Standard (GICS) were developed by and is the exclusive property
of MSCI and Standard & Poors. GICS is a service mark of MSCI and S&P and has been licensed
for use by The Goldman Sachs Group, Inc.

40

2015 12 3

, Ph.D

25-35%10-15%

(A) 12
(N) 12 (C) 12

(NR)
(RS)
() (CS)
(NC) (NA) (NM)

()

http://www.theocc.com/about/publications/character-risks.jsp

2015
(i)(ii)

41