As The Dust Settle.

Strategy
Top four picks that offer value, stability and liquidity
As a result of fears over credit tightening in China, the US credit market
turmoil and a likely US recession, global stock markets have experienced
panic selling in the past two days. Despite the near-term uncertainties, we
believe that when the dust settles, investors will shift their focus back to
fundamental value. In this note, we highlight our top four large-capped picks
that offer value, stability, liquidity and medium-term upside potential. Our
picks include China Mobile, China Shenhua, Datang and PetroChina.
Meanwhile, HK Exchanges, a high-beta play, is interesting at this juncture as
the share price has already dropped below the SAR government’s average
purchase price.
Our base-case scenario. At this juncture, we have not changed our positive
view on China’s economy. We believe that despite an expected slowdown in
China’s exports to the US, China’s exports will still grow 18% in 2008 (vs 26%
in 2007) thanks to the strength in exports to emerging markets, which
accounted for 30% of total exports in the first nine months of 2007. Also, firm
domestic consumption and investment, which account for a total of 79% of
GDP, will be able to offset the slowdown in external demand. Should exports
drop much more than we expect, the government still has room to increase
spending and loosen monetary policy so as to offset the impact of weak
external demand. Thus, we believe China’s GDP will still grow at above 10%
in 2008 despite all the difficulties. The solid economic growth, the Rmb
appreciation and the tax unification should translate into fairly good corporate
earnings in 2008. This is the reason why we have a base-case target of
21,000 for the benchmark HSCEI.
What if we are wrong on our forecast? With the HSCEI closing at 11,911
yesterday, the market is telling us that the future situation will be much worse
than our base-case forecast. To give us the margin of safety, we have done
a scenario test that estimates the fair values of a group of large caps under
their respective worst-case scenarios. Based on this exercise, we have
selected four stocks with their worst-case fair values above their current
share prices. Additionally, given the current market turbulence, these stocks
have to offer earnings stability, shares liquidity and medium term upside.