The alpha of BRIC countries, China has had a rough first half of 2012. The bad economic year led to decrease in earnings forecast for the coming quarters. In the past four weeks some of the worst performance was seen in A and H class shares, while on the other hand the North Asian markets rallied with support from the European sovereign crisis. The earnings season was the worst that China saw in the last five years. Societe Generale SA (EPA:GLE) (PINK:SCGLY) thinks that the slice in earnings forecast is still not sufficient, and the investment banking firm has given out some interesting data points to consider, when it comes to how economics evolves in the Chinese market. In a comparison of the level of worst performance, the H shares did not do as bad as A shares.

SocGen has based its valuation of Chinese market on the CSI 300 exchange, rather than Hang Seng China Enterprises Index (HSCEI), it believes the latter does not get the full scope of the businesses involved. An even lower forecast for the upcoming quarters is needed, because as a whole, the other analysts are still predicting the earnings to rise by 15%, contrarily the Chinese earnings are actually reducing on a y-o-y basis.  The following chart shows how the earnings are broken down with respect to sectors, according to other equity analysts.

 

While Societe Generale SA (EPA:GLE) (PINK:SCGLY) is reducing exposure in China, WisdomTree India Earnings Fund (ETF) (NYSEARCA:EPI), an ETF based asset manager,  has recently opened a new fund China Dividend ex-Financials Fund (CHXF) that is designed to provide exposure to Chinese equities excluding financials. IShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI), which has has more than 50% of its allocation Chinese banks.

Coming back to SocGen, their research finds the predictions overly optimistic, its own analysis estimates the earnings to contract by 2 percent for 2012. For the next year, the expected EPS growth is 13 percent. The drop in earnings will also take the share prices down by 15 percent, i.e. CSI 300 will fall to 1930 bp from 2300. The codependence in share price and earnings have been a contemporary feature of the Chinese market, and the only ‘mismatching’ year was 2008-2009.

 

SocGen’s Chinese economist Wei Yao thinks that GDP growth will fall below 7 percent in 2015 and 2016. SocGen’s regression model, formulated in  Feb 2012, estimated earnings to fall lower than their present level. The analysts have now reformatted the scale to include more indicators according to each subsector.

Trade Recommendations

SocGen’s models have changed, as it does not expect China to outperform Australia, therefore it is not short on Australian Securities Exchange (ASX) anymore. SG has also closed its sell position on Taiwan Stock Exchange (TWSE) and buy position on Asia excluding Japan contracts.

The buy recommendations are Japan’s NIKKEI 225 (INDEXNIKKEI:NI225), Shanghai Stock Exchange Composite Index (SHCOMP), and sell S&P CNX Nifty Index.