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2Q18 A-Share Market Outlook Summary

Core Content

The A-share market in the second quarter of 2018 is expected to experience fluctuations and rebalancing. This is due to a combination of factors that will adjust previous misexpectations and influence investor behavior.

Main Factors Driving the Market

1. Adjustment of Expectations:

   • Expectations about a severe contraction in mid-term credit supply will be revised upward as economic growth is more optimistic than previously anticipated.
   • Interbank liquidity conditions, which were previously loose, are expected to become more neutral, leading to a slight rebound in long-term interest rates.
   • Divergence in risk appetite across different markets and sectors will be adjusted, with risk aversion in overseas markets likely to ease and interest in new economy sectors to cool slightly.

2. Market Dynamics:

   • The A-share market is on a slow-bull trajectory, experiencing fluctuations.
   • The preference for industry leaders is expanding to include leaders in smaller sub-sectors.
   • The market is shifting focus from market cap premiums to "growth premiums," emphasizing stocks with strong future growth potential.

3. Earnings and Valuation Trends:

   • Corporate earnings are expected to first decline and then rebound later in 2018.
   • A turning point in ROE (Return on Equity) has emerged, with limited downside.
   • The "growth premium" is materializing due to a decline in stock value discount rates, favoring mid-cap stocks.

Sector Performance and Investment Opportunities

• Previously Oversold Sectors:

  • Property: Despite tightening measures, fundamentals remain positive, and market sentiment is overly pessimistic.
  • Coal: Stable supply and demand dynamics.
  • Securities: Fundamentals are at a turning point.

• Sectors with Capacity Expansion Potential:

  • Pharma & chemical
  • Materials & packaging
  • Machinery

• Preferred Sectors with Favorable Conditions:

  • Retail, healthcare, and food processing benefit from policy support and ongoing consumption upgrades.
  • Sectors with valuations that properly reflect their business conditions, such as electronic components, traditional Chinese medicine, and media, are also favorable.

• Thematic Investment Opportunities:

  • New retail models
  • Integration of defense industry development with economic growth
  • Rural rejuvenation
  • Semiconductors

Risks

• Escalation of trade friction
• Faster-than-expected credit tightening
• Earnings disappointments from certain companies

Valuation and Market Trends

• The return of "unicorn" firms to the A-share market will help establish high-quality valuation benchmarks, potentially reducing the valuations of new economy sectors.
• Mid-cap stock valuations are becoming more attractive following continued declines.
• The "supply-side structural reform" in capital markets is expected to enhance valuations of companies with solid fundamentals and reduce valuations of weaker ones.

Rating Definitions

Company Ratings:

• Buy: Expected to outperform the benchmark by more than 15%
• Accumulate: Expected to outperform the benchmark by more than 5% but not more than 15%
• Hold: Expected relative performance ranges between -5% and 5%
• Underperform: Expected to underperform the benchmark by more than 5%

Sector Ratings:

• Positive: Expected to outperform the benchmark by more than 10%
• Neutral: Expected relative performance ranges between -10% and 10%
• Cautious: Expected to underperform the benchmark by more than 10%

Analyst Certification and Disclosure

• The research analyst(s) certifies that all views expressed accurately reflect their personal opinions.
• No part of their remuneration is directly or indirectly linked to the specific recommendations in this report.

Disclosure of Interests

• GF Securities (Hong Kong) and its affiliated companies do not hold any shares of the securities mentioned in the report.
• No investment banking relationship with the companies mentioned in the report within the past 12 months.
• Analysts and their associates do not serve as officers of the mentioned companies and have no financial interests in the securities.

Disclaimer

• This report is for informational purposes only and does not constitute an offer to buy or sell securities.
• The research is intended solely for use by GF Securities (Hong Kong)'s clients.
• No action has been taken to permit distribution in jurisdictions where it is unlawful.
• GF Securities (Hong Kong) accepts no liability for losses arising from the use of this report.
• The report does not consider the specific investment objectives, financial situation, or needs of any individual.
• The views and opinions expressed are those of the analysts and may change without notice.
• The proprietary trading division may have different investment decisions and may deliver opposite views to clients.