Strategy

�� Global investment environment to remain tough in 2H08 - no thanks to strong oil prices, uncertain US credit and housing market outlook, fears of more price caps on key inputs and stubborn inflation in China. These negatives have speeded up correction of China stocks.

�� Both H- and A-shares are bottoming out, supported by undemanding valuations, still-solid economic performance and expected moderation in CPI.

�� Expect supportive measures from Beijing in run-up to 2008 Olympics, possibly triggering mini rally that could lift the HSCEI to 15,500 in 3Q08.

�� Macro headwinds and possibility of more earnings downgrades for 2008 will keep market volatile in 4Q08. Worst-case downside for the HSCEI is 11,500 (11x 2009 projected

earnings).

�� China stocks should stage comeback in 2009 with Beijing’s ability to control inflation and maintain economic growth, along with recovery in corporate earnings. We have

identified two investment themes – massive rail investment and continued urbanisation, which should work well in both 2H08 and the next bull market.

�� OVERWEIGHT banks, insurance companies, consumer, coal, metals and agriculture, MARKET WEIGHT property, shipping and oil & gas sectors and UNDERWEIGHT telecoms, power and power equipment sectors.

�� Top stock picks are China Dongxiang, China Merchants Bank, China Mobile, China Railway Group, China Shenhua Energy, Sinopec, Golden Eagle, Hidili, Ping An Insurance and NWS. SELL Harbin Power and Lianhua Supermarket.

 

In the medium term, we have identified two investment themes which are

likely to work well in the next bull cycle. The first theme is urbanisation. This

theme worked well in the last cycle and many related sectors – such as retailers,

food & beverage, housing and financial stocks – experienced a major re-rating.

The sharp pullback in 2008 provides a great opportunity to accumulate this

group as urbanisation is likely to continue in the years ahead. However, investors

have to focus on companies that have strong pricing power and are able to pass

on cost increases to customers. The second theme is massive rail investment.

As a result of the bottlenecks in the railway transportation system, the central

government will speed up investment in the railway network in 2008 – 2010,

which provides enormous opportunities for construction companies, equipment

makers and railroad operators. Our 2009 year-end target for the H-share index

is pegged at 19,000, which represents 18x our estimate for 2009

Agreed.

Note also 2922 resistance still holds. Tested 2923, but not broken.

Unless some magical chiong in USD or drop in oil price below $130 materialises, or earnings reports come out far better than expectations in the upcoming season, don't expect any strong bull.