JPM China Strategy 112410

Asia Pacific Equity Research
24 November 2010
China Strategy
Short-term cautious, medium-term positive
• We take a short-term (1-2M) cautious view on MSCI China, which China

could experience correction pressure from concerns about likely Frank Li
AC
tightening measures to be taken by the Chinese government. These could (852) 2800-8511
include: (1) monetary measures such as RRR and interest rate rises, and frank.m.li@jpmorgan.com
credit quota controls to sterilize excess liquidity; (2) fiscal policies such Peng Chen
as a possible slowdown in government-sponsored investment projects; (852) 2800-8507
and (3) administrative measures such as price caps on soft commodities. peng.p.chen@jpmorgan.com
• We maintain our medium-term (12M) positive stance on MSCI Lan Deng

China because: (1) the risk of inflation running out of control in China
has been exaggerated, in our view, as: (a) food inflation has contributed
J.P. Morgan Securities (Asia Pacific) Limited
to 71% of the headline CPI inflation since July, and the sharp rise in
food and agricultural prices is mainly driven by excess liquidity flowing Relative index performance
out of the property market into the agricultural produce market; and (b)
price caps on soft commodities will help reduce inflationary expectations; 550
(2) we still see an overall solid economic and corporate growth outlook 450
for China; (3) the liquidity situation is still accommodative for equities 350
due to ample excess reserves in the banking system, and money flowing 250
out of debt markets and bank saving accounts into equity markets; (4) 150
MSCI China is trading at what we believe to be an undemanding 50

Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10
valuation of 15.0x FY10E P/E, below its long-term average trailing P/E HSCEI Index SHCOMP Index MSCI China
of 16.0x; and (5) MSCI China’s increasing attraction on Rmb

Source: Bloomberg.
appreciation expectations. The key, in our view, is whether the
government can reign in the inflationary pressure. Before it has achieved
this, it is unlikely to loosen its tightening measures, which could have a
negative impact on Chinese share performance.
• Key sector views: We are positive on: (a) insurance; (b) IT; (c)
consumer, especially luxury consumption names, retailers, and menswear;
(d) service industries such as IT outsourcing, healthcare, auto after sales
service, and education; (e) economic housing beneficiaries; (f) coal
machinery; and (g) banks. We are negative on: (a) mid-stream processing
industries such as steel and aluminum; (b) paper; and (c) IPPs and
refineries, on a possible delay of electricity tariff and refinery product
price rise due to inflation concerns. Finally, we prefer wind power
operators to wind power equipment producers.
China top picks
JPM RIC Mkt cap EPS Y/Y growth (%) P/E (x) P/BV (x) ROE (%) Div. yld (%)
Rec ticker (US$MM) 2010E 2011E 2010E 2011E 2010E 2010E 2010E
Ping An Insurance Group - A OW 601318.SS 76,520 20.5 35.8 25.6 18.9 3.7 17.0 0.8
Industrial and Commercial
Bank of China - H OW 1398.HK 256,609 27.3 18.7 10.6 8.9 2.6 22.5 3.5
Belle OW 1880.HK 16,119 33.1 25.3 34.8 25.4 6.5 19.8 1.4
Lenovo Group Limited N 0992.HK 7,149 n.m 78.0 46.8 26.3 3.8 3.2 1.1
VanceInfo Technologies Inc. OW VIT 1,509 29.6 29.7 53.4 41.2 8.0 16.2 0.0
Source: Company, Bloomberg, J. P. Morgan estimates. Share prices and valuations as of 22 November 2010.
See page 33 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision.
Frank Li Asia Pacific Equity Research
(852) 2800-8511 24 November 2010
frank.m.li@jpmorgan.com
Table of Contents
We take a short-term cautious view on MSCI China .............3
Rising concerns about possible near-term tightening measures...................................3
Rally could resume if inflation is contained...........................8
Sector views ...........................................................................17
China Model Portfolio (CMP) adjustments ...........................28
Model portfolio adjustments ......................................................................................28
2
(852) 2800-8511 24 November 2010
We take a short-term Rising concerns about possible near-

term tightening measures
cautious view on MSCI The markedly higher-than-expected headline CPI in
China October (which was at 4.4%oya versus the consensus
forecast of 4.0%) and reported skyrocketing of food
prices (prices of 18 vegetables monitored by the
We take a short-term (one-two months) cautious view on government rose by 62.4% Y/Y in China in the first 10
MSCI China, which could see correction pressure due to days of November) mean that the government may have
market concerns about possible tightening measures to be to adopt more stringent tightening measures to curb
adopted by the Chinese government to contain rising rising inflationary pressure.
inflationary pressure, especially after a notable stock
market rally in China since late September. We believe these measures could include: (1) monetary
measures such as RRR increases, rate rises, credit quota
Indeed, a similar situation occurred earlier this year, with
controls and enlarged issuance of PBOC notes, to
the market experiencing rising volatility on the back of
sterilize excess liquidity; (2) fiscal policies such as a
the turmoil triggered by tightening measures. MSCI
possible slowdown in government-sponsored investment
China lost 11.2% in less than one month following the
RRR increase on January 12, 2010—the first RRR rise projects; and (3) administrative measures such as price
since 2H08, which was deemed as a signal for China’s caps on certain soft commodities.
monetary tightening at that time.
Figure 3: China—Consumer price index
%oy a %3m/%3m, saar
Figure 1: Price movements in basis points (as of November 19,
2010) %3m/3m,saar
10 15
300 %oya
250
8 10
200 6
150
5
100
4
0
50 2
0
0 -5
-2 -10
08
/09
09
/10
10
09
10
/08
/09
/09
/10
/0
/1
ct/
ct/
ct/
n/
n/
pr
pr
ug
ug
ec
ec
eb
eb
/Ju
/Ju
/O
/O
/O
/A
/A
/D
/D
/A
/A
/F
/F
2002 2003 2004 2005 2006 2007 2008 2009 2010

27
27
27
27
27
27
27
27
27
27
27
27
27
MSCI EM MSCI China
Source: Bloomberg. Source: CEIC, J.P. Morgan estimates.
Figure 2: MSCI-China YTD price performance by sector Figure 4: China—Headline CPI and CPI inflation
%oy a, both scales Core CPI
Utilities -7.0% Energy & food
CPI
20
Materials -0.6%
15
Financials 2.4%
10
IT 2.6% 5
0
Consumer Staple 5.4%
-5
MSCI China 5.7% 02 03 04 05 06 07 08 09 10
Industrials 8.1%
Source: CEIC, J.P. Morgan estimates.

Telecom 8.2%
Consumer Disc 8.2%
Energy 14.7%
Health Care 16.5%
-10.0% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0%
Source: Bloomberg. Updated as of November 19, 2010.
3
(852) 2800-8511 24 November 2010
Figure 5: China—Headline CPI, food prices and non-food CPI negative interest rate problem, thus reducing the pressure
inflation for the migration of Chinese residents’ deposits out of
%oy a, both scales
banks. On the other hand, a rate rise will increase the
CPI CPI: food
10 25 interest payments for China’s enterprises. Moreover, an
prices
8 20 interest rate rise will widen the spread between the
Nonfood CPI
6 15 benchmark interest rate in China and that in the US,
4
10 which could attract more “hot money” into China. The
2
0 5 concerns about “hot money” inflows on the widening
-2 0 interest rate spread between the US and China should
-4 -5
help limit the magnitude of the interest rate increases in
2002 2003 2004 2005 2006 2007 2008 2009 2010 China.
(c) The government may want to reduce the new loan
(1) On the monetary policy front, our economics team creation quota for FY11, and ask banks to adopt a more
now looks for two more 50bp RRR increases in coming evenly spread lending practice in FY11. Local press has
months, and three 25bp rate rises next year, with the next reported that the FY11 new loan creation target will be
interest rate increase coming in possibly by 1Q11. limited to below Rmb6.5 trillion from Rmb7.5 trillion for
FY10. (Source: finance.sina.com.cn).
That said, there is a risk that Chinese authorities will
choose to increase RRR or interest rates even earlier than Hence, the market may be wary of the uncertainties on
our forecast if China’s November and December the monetary tightening front until the Central Economic
inflation data turn out to be significantly above our Work Conference, China’s most important annual
expectations, given the Chinese government’s preference official economic conference to be held in early
for adopting pre-emptive measures to contain inflationary December each year, brings about more clarity on the
pressure. Such monetary tightening policies, if adopted, monetary tightening front.
could hurt market sentiment for China’s stock market.
Figure 6: China—Reserve requirement ratios for financial
institutions
Source: CEIC, J. P. Morgan estimates.
That said, we believe the above monetary tightening

measures will only have limited success in sterilizing the
excess liquidity in China. This is because:
(a) One RRR rise will only sterilize about Rmb350

billion of liquidity in the banking system, which does not
seem enough to sterilize the excess liquidity created by
the money inflows into China, as indicated by the much
larger scale of foreign exchange reserve accumulation in
China (US$194 billion in 3Q10, or a monthly average of
US$64.7 billion).
(b) On one hand, an interest rate rise can send a strong

signal about the government’s determination to solve the
4
(852) 2800-8511 24 November 2010
Table 1: Summary of the monetary policy tone at the Central Economic Working Conference
Year Overall monetary policy tone at the Central Economic Policy in the Central Economic Working Conference (CEWC)
Working Conference (CEWC)
2004 To enhance and improve macro-regulation, promote reform and The government plans to further enhance and improve macro-regulation to
opening-up, push forward economic structure adjustment and ensure a stable and comparatively fast economic growth; push forward
transformation of economic growth pattern and realization of all- structural adjustment and transformation of the pattern of economic growth;
round, balanced and sustainable economic and social boost economic system reform to ensure all-round, balanced and sustainable
development. development; coordinate domestic development and the opening up and
improvement of international competitiveness; establishment of a harmonious
society.
2005 To maintain the continuity and stability of the macroeconomic The government will step up efforts to maintain the momentum of fast
policy, improve the quality and efficiency of economic growth in an economic growth; promote the development of sectors concerning agriculture,
effort to realize fast and healthy development farmers and rural areas; promote innovation and adjustment of the industrial
structure to build an energy-efficient and environmentally-friendly society;
promote the coordinated development of regional economies; further links with
the outside world; address issues concerning the rights and interests of the
people
2006 To realize a sound and fast economic growth The government is committed to enhancing and improving macro-regulation to
maintain and boost the momentum of economic growth. It will focus more on
developing the rural economy and promoting the building of a new socialist
countryside. Other issues on the government’s 2007 economic work agenda
included pushing forward optimization of industrial structure, promoting
innovation and urbanization, and further enhancing social harmony.
2007 To prevent economy overheating and inflation CEWC reiterated the goal of avoiding economic overheating and widespread
inflation, while at the same time maintained a “stable and relatively high level of
growth.” On the policy front, the summit announced a shift to what the
authorities term a “tighter” monetary policy stance from a “neutral” one, along
with a continued neutral fiscal policy stance for 2008.
2008 To maintain a stable and relatively fast economic growth The government pledged to maintain stable and healthy growth next year
through an active fiscal policy and moderately easy monetary policy. In
particular, the government will increase spending substantially and cut taxes
next year to increase support for job creation, agriculture, social security,
education, energy conservation, and small and medium-sized enterprises.
Regarding the exchange rate, the government reiterated that China will keep
the yuan essentially stable at reasonable levels. Meanwhile, the government
emphasized stable and healthy development in both property and capital
markets.
5
(852) 2800-8511 24 November 2010
2009 To reiterate stability and continuity and focusing on supporting As expected, the descriptions of “proactive fiscal policy” and an “appropriately
domestic demand, particularly private consumption, going into accommodative monetary policy” stance were unchanged in the statement
next year. following the conference. On monetary policy, while the conference
emphasized the continuity and stability of the policy stance, it also highlighted
the importance of flexibility, suggesting that the pace of credit expansion
should be managed and adjusted according to changes in the global and
domestic economies. Credit support should be channeled to sectors with
greater impact on employment, new strategic industries, and small and
medium-sized enterprises.
Source: PBoC.
(2) Fiscal policy adjustment: The government could growth tends to see a rising momentum in the first three
tighten control over the approval of new investment years of each Five-Year Plan, before slowing down in the
projects fourth and fifth year of each Five-Year Plan.
The downshift in China’s FAI growth since mid-2010
has moderated somewhat in 4Q10. That said, if we look Figure 8: China’s average nominal and real FAI growth in each
year of the past Five-Year Plans (7th to 11th)
at the ongoing and new investment projects, we find that
%
the growth rates of ongoing and new investment projects
40.0 32.3
actually have seen a declining trend since July FY10.
30.0 23.6 23.5
19.8 20.5
Figure 7: China—Ongoing and new fixed-asset investment 16.9 17.5
20.0 14.2
projects 10.2
%oy a, y td, both scales 7.5
10.0
40 100 0.0
On-going projects
26.7 75 1st yr of FYP 2nd yr of FYP 3rd yr of FYP 4th yr of FYP 5th yr of FYP
30
50
Nominal FAI growth Real FAI growth
20 25
23.8 0 Source: CEIC, J.P. Morgan Economics.
10 New projects
-25
(C) Our observation that the manufacturing FAI should
0 -50
2006 2007 2008 2009 2010 get a boost from the expected recovery in the domestic
and export capital goods demand in 2H11.
(3) Possible administrative measures such as price
In the near-term, we believe the Chinese government will caps on soft commodities
probably tighten control over new investment project
approvals so as to help suppress the inflationary pressure. One of the powerful toolsets of the Chinese government
Hence, we still expect some further moderation in private to fight the rising inflationary pressure is to adopt
real estate investment growth given the expected increase temporary price caps, as it did in late 2007/early 2008.
in supply and the government’s curb on speculation and
investment demand. This time was no exception. On November 17, 2010,
China’s State Council announced that the government is
That said, we hold our view that China’s overall FAI ready to put temporary price controls on daily necessities,
growth will remain rather resilient in 2011 because of: to step up the supervision and to regulate the market
order of major agricultural produces, and to crack down
(a) the increased investment from public economic on speculative activity in soft commodities such as cotton
housing front; and corn, in order to contain inflationary pressure.
Meanwhile, the government has promised to offer
(b) the expectation that we should see new investment temporary subsidies to low-income families. Local press
projects kicking off by the end of this year and early next quoted Premier Wen as saying that efforts would be
year, with FY11 being the first year of the 12th Five- made to ensure adequate market supplies, improve
Year Plan. Normally China’s fixed asset investment subsidy systems, make price controls more targeted and
6
(852) 2800-8511 24 November 2010
effective, and to strengthen market supervision. (Source: price controls as a “fast-track” mechanism to contain the
Xinhua News) inflationary pressure.
In our view, these policies, which are targeted at select For instance, the Chinese government successfully
agricultural products, will hurt certain consumer staple contained inflation in 2008 through price caps on soft
sectors which are put under price caps. commodities and natural resources in late 2007/early
2008, on top of a supply side improvement for pork
That said, the price caps should help reduce inflationary products as well as a demand slowdown due to the
expectations, and a possible crack-down on the external final demand deterioration since early 2008.
speculation about soft commodities may help alleviate
the pressure arising from the hoarding of agricultural As shown in Figure 9, China’s CPI inflation peaked at
produce. Hence, the positive effect of these 8.7% in Feb-08, one month after the adoption of the price
administrative measures should not be underestimated. control measures.
Given that it will take a relatively long time to contain

inflationary pressure through interest rate increases, the
Chinese government might be inclined to use temporary
Figure 9: The Chinese government’s price cap in Jan-08 and subsequent moderation in headline CPI towards 2H08 (%)
10.0 CPI peaked out at 8.7%oy a in Feb 2008 120

CPI yoy growth fell to 4.9% oya six months after the adoption
of price caps measures .
8.0 100
6.0 80
4.0 60
China introduced administrativ e measures to
control prices for oil,energy , utilities, and
2.0 40
essential food itemsl in Jan 2008.
0.0 20
-2.0 0
Nov -07 Jan-08 Mar-08 May -08 Jul-08 Sep-08 Nov -08
CPI (LHS) MSCI China (RHS)
Source: Bloomberg, J.P. Morgan estimates.
7
(852) 2800-8511 24 November 2010
In a sense, the temporary price control measures as component contributed 3.3%pt to headline inflation,
adopted by the Chinese government should be seen as followed by 0.65%pt from residence component and
preemptive measures to prevent the nascent inflationary 0.37%pt from the medicine and medical care component.
risks from running out of control, i.e. spiraling into a
very high-single-digit level. Figure 10: Consumer price index—Inflation is back
% oya % 3m/% 3m, saar
From this perspective, the price-cap measures could 10 %3m/3m,saar 15
potentially reduce the inflationary risk undermining
China’s healthy economic growth, and hence, reduce the 8 10
%oya
risk for Chinese equities. 6
5
4
0
2
Rally could resume if 0 -5
inflation is contained -2 -10
2002 2003 2004 2005 2006 2007 2008 2009 2010
Despite the possible near-term correction pressure, we
maintain our positive view on MSCI China’s Source: CEIC, J.P. Morgan Economics team estimates.
performance over the next 12 months.
Figure 11: Producer price Inflation is elevated
Once inflation pressure is contained, we could see the Producer prices Producer prices
resumption of the rally. Two potential major drivers of %oya Producer prices (PBoC)
the rally—liquidity and solid economic and corporate (NBS)
12
growth outlook—remain largely unchanged.
8
(1) Inflation pressure still manageable; 4
hyper inflation is not likely 0
We maintain our view that: (1) the risk of inflation -4
running out of control is exaggerated; and (2) any sign of -8
the government successfully containing inflationary -12
pressure could touch off a new round of rally as we
2002 2003 2004 2005 2006 2007 2008 2009 2010
believe the Chinese stock market has already priced in a
Source: CEIC, J.P. Morgan Economics team estimates.
lot of bad news about surging inflation, and the Chinese
stock market tends to perform well under a mild
Figure 12: Headline CPI and core CPI inflation—Led by food
inflationary environment. prices
The risk of inflation running out of control in China % oya, both scales Core CPI
Energy & food
may be exaggerated 20 CPI
We believe the Chinese economy’s demand bottomed out
15
in 3Q this year, and is far from facing a state of
overheating. The recent sharp rise in CPI was mainly due 10
to the sharp rise in food and vegetable prices, rather than
5
due to a broad-based price increase caused by overall
economic over-heating. 0
Notably, food inflation on an average has contributed to -5

71% of the headline CPI inflation since July, with the 02 03 04 05 06 07 08 09 10
rest coming from non-food inflation. Among the
Source: CEIC, J.P. Morgan Economics team estimates.
4.4%oya headline inflation in October, the food
8
(852) 2800-8511 24 November 2010
Table 2: Percentage contribution to headline CPI growth (%oya) by component

Headline Food Clothing Household facilities Medicines and Traffic and Recreational, Residence Tobacco and
and articles medical care communications educational, and Alcoholic
appliances cultural service products
Weight 100.0% 33.2% 9.1% 6.0% 10.0% 10.4% 14.2% 13.2% 3.9%
Jan 10 1.50 1.21 -0.04 -0.07 0.23 -0.05 -0.17 0.33 0.06
Feb 10 2.70 2.03 -0.12 -0.05 0.24 0.01 0.11 0.40 0.06
Mar 10 2.40 1.70 -0.10 -0.04 0.25 0.00 0.04 0.44 0.07
Apr 10 2.80 1.93 -0.12 -0.03 0.28 0.00 0.06 0.59 0.07
May 10 3.10 2.00 -0.11 -0.02 0.32 0.01 0.09 0.66 0.07
Jun 10 2.90 1.87 -0.09 0.00 0.32 -0.03 0.13 0.66 0.07
Jul 10 3.30 2.23 -0.07 0.01 0.33 -0.07 0.16 0.63 0.06
Aug 10 3.50 2.46 -0.11 0.02 0.33 -0.06 0.17 0.58 0.06
Sep 10 3.60 2.62 -0.14 0.02 0.34 -0.07 0.17 0.57 0.05
Oct 10 4.40 3.31 -0.12 0.03 0.37 -0.05 0.13 0.65 0.06
Source: CEIC, J. P. Morgan economics.
Hence, while we do not rule out the possibility of the CPI Figure 14: White sugar’s settlement price in Zhenzhou
approaching or even briefly breaking the 5% inflation Commodity Exchange
mark in the coming month or two, we hold our view that 8000
the chance of CPI running out of control, i.e. CPI 6000

escalating into a high-single-digit level, remains small. 4000
This is because: 2000
0
(1) There is no shortage of food or agricultural products 19-Jan-10 19-Mar-10 19-May-10 19-Jul-10 19-Sep-10 19-Nov-10
in China. The state grain reserves remain at a high level 1st m settlement price for w hite sugar
after three consecutive years of a bumper harvest. Source: CEIC, J.P. Morgan Economics.
(2) The sharp rise in food and agricultural prices is Figure 15: Corn’s settlement price in Dalian Commodity
mainly driven by excess liquidity flowing out of the Exchange
property market (which has been under the government’s 2200
clamp-down) into the food and agricultural product 2100
2000
markets. 1900
1800
As shown in Figure 13, prices of grains such as cotton 1700
and white sugar have suffered a sharp fall on news of a 1600
1500
possible price cap and crack-down by the government.
10
10
0
0
0
-1 0
10
-1 0
-1 0
-1 0
-10
l-1
n -1
n -1
Figure 13: Cotton settlement price in Zhenzhou Commodity

p r-
c t-
a r-
eb
ug
ep
ov
-J u
ay
-J a
-J u
-O
-A
-M
-A
-S
-F
-N
-M
19
19
19
Exchange
19
19
19
19
19
19
19
19
35000 1st m settlement price for corn

30000
25000 Source: CEIC, J.P. Morgan Economics.
20000
15000
10000
Meanwhile, according to www.agri.gov.cn, the wholesale
5000 prices of vegetables such as leek and lettuce in the
0 Beijing wholesale market dropped by 39% and 31% from
19-Jan-10 19-Mar-10 19-May-10 19-Jul-10 19-Sep-10 19-Nov-10 November 10 to November 20, respectively.
1st m settlement price for cotton
Source: CEIC.
9
(852) 2800-8511 24 November 2010
Figure 16: China—Agricultural index Figure 18: China—Headline CPI forecast and base effect in 2011
178 Headline CPI and base effect Headline CPI
%oy a
5
176 4.6 4.4
4.1 4.2 4.1 4.0 4.1
4 3.9
3.2 3.0 3.2 3.1
3
174
2
Base effect's contribution to
1 headline CPI
172
30-Oct-10 1-Nov -10 3-Nov -10 5-Nov-10 7-Nov-10 9-Nov -10 11-Nov - 13-Nov- 15-Nov - 17-Nov - 0
10 10 10 10 Jan-11 May-11 Sep-11
Agricultural retail price "The basket" agricultural retail price Source: CEIC, J.P. Morgan Economics.
Source: www.agri.gov.cn.
(4) The government’s recent moves on RRR rises and
possibly interest rate increases in coming months should
Hence, we expect China’s food and agricultural prices to
be seen as pre-emptive moves to contain inflationary
gradually stabilize in early FY11 on improving supply
expectations, in our view, which could help reduce the
conditions, and a potential government invention.
risk of hyper inflation in China.
(3) The high base effect will kick in as we approach 2H
Hence, we expect China’s food and agricultural prices to
next year, which should result in headline CPI inflation
gradually stabilize in coming months on improving
gradually fading away by mid next year.
supply conditions, and potential government invention,
In other words, other things being equal, the base effect which should help remove a major driver of inflationary
should translate into CPI inflation going up H/H in 2H pressure in China.
FY10, before going down H/H in 1H FY11.
In our view, the risk of inflation running out of control in
China is exaggerated.
Figure 17: China—Headline CPI forecast and base effect in 2010
Headline CPI and base effect Headline CPI Notably, the sharp fall in China’s equity market, with
%oy a MSCI China index down by 6.2% from November 8 to
5 Base effect's contribution to November 22 should have already priced in a lot of bad
headline CPI 4.4 news about the risk of the inflation rising out of control.
4 4.0
3.6 3.6
3.1 2.9 3.3 3.5 Hence, any sign of inflation pressure being contained
3 2.8
2.7 after a series tightening measures should be taken
2.4
2 positively by the market, touching off a new round of
1.5 rally for the Chinese stock market, in our view.
1
Chinese equities tend to perform well in the early stages
0 of monetary tightening
Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Overall, we believe a scenario of accelerating economic
growth coupled with mild inflation pressure would be
Source: CEIC, J.P. Morgan Economics.
accommodative for Chinese equities. Under such a
scenario, we could see the potential for both solid
earnings growth and multiple expansion for Chinese
equities.
Notably, within the last around of the bull market from

2005 to late 2007, MSCI-China still managed to surge by
97% from January 2007 to October 2007, even though
CPI inflation rose notably from 2.2%oya to 6.5%oya
over the same period. The rally did not fizzle out until
10
(852) 2800-8511 24 November 2010
late 2007, when the headline CPI broke 7%-level and

when intensified tightening measures from the Chinese
government eventually battered the rally.
Figure 19: The MSCI-China index performance and the headline CPI inflation in the 2007 bull market
MSCI China surged 97% from 1 Jan CPI peaked out at 8.7%oy a in Feb 2008
%oya
2007 to 31 Oct 2007, despite a jump in
10.0 CPI inflation from 2.2%oy a in Jan 2007 120
8.0 to 6.5% in Oct 2007. 100
6.0 80
4.0 60
2.0 40
0.0 CPI (LHS) MSCI China (RHS) 20

-2.0 0
Jan/07 Apr/07 Jul/07 Oct/07 Jan/08 Apr/08
Source: CEIC, Bloomberg, and J. P. Morgan Economics.
11
(852) 2800-8511 24 November 2010
Figure 20: H-shares’ index performance and tightening measures in 2007

21000 Increased dow npay ment Gasoline and diesel
Establishment of the China requirement for the 2nd house prices increased
Inv estment Corporation
HK$ starting w ith an asset size of
RRR hike on RRR hike on Dec 8
Oct 13
US$200 billion. China’s State Council this
w eek decreed a near-
term halt to domestic price
Further tightening on foreign entities
Charge of a penalty of increases for oil products,
entering into high-end property
equiv alent to 20% of land natural gas, and
dev elopment
The market bitten by US premium for idle land to electricity .
17000 sub-prime spillov er and dev elopers
On May 30, Ministry of Finance (MOF) consequent credit
announcement of the stamp duty tax for contraction.
stock transactions increase from 0.1% to Announcement of the
0.3%. MoF to issue Rmb1.5 DII scheme. Mkt rallied. RRR hike on
trillion special treasury Nov 10
The ex pansion of QDII
bonds
program. Mkt rallied.
Enforcement The market hav e been pushed up on Dec 20, PBoC raised
of LAT. Mkt high by the belief that the lending rate by 18bp and
RRR hike by
dropped. H share declined on gov ernment w ould not w ant to deposite rate by 27bps
13000 50bps on April 5
the concern of see the market going dow n before respectiv ely
and April 29
policy tightening. the Chinese Party Congress.
respectiv ely
PBoC raised lending
rate and deposite
on July 20, PBoC rate on Sep 14
raised lending rate and
deposite rate by 27bp
Market correction driv en by sub
respectiv ely RRR hike by RRR hike on Sep 6
prime concerns, US economic
50bps on July 30
slow dow n and DII delay
9000 RRR hike
by 50bps on on Aug 21, PBoC raised
Jan 5 lending rate and deposite rate
RRR hike by on May 18, PBoC raised lending rate by by 27bp respectiv ely
50bps on Feb 18bp and deposite rate by 27bps
on March 18, PBoC
16 respectiv ely , raised RRR to 11.5%;
raised lending rate and
deposite rate by 27bp w idened CNY daily trading band from
respectiv ely 0.3% to 0.5%.
5000
2007/1/1 2007/2/1 2007/3/1 2007/4/1 2007/5/1 2007/6/1 2007/7/1 2007/8/1 2007/9/1 2007/10/1 2007/11/1 2007/12/1 2008/1/1
Source: Bloomberg, J. P. Morgan estimates.
12
(852) 2800-8511 24 November 2010
(2) Solid economic and corporate Figure 22: China—IP and PMI output
%3m/3m, saar Output (NBS) Index , sa
growth outlook
40 Real IP 80
On one hand we maintain our view that the government
30 70
will take a series of tightening measures such as RRR 20
rises, interest rate increases, credit quota controls, or a 60
10
slowdown in the approval of the investment projects to 50
0
contain the inflationary pressure in China. This, in turn, -10 Output (Markit) 40
may have a negative impact on China’s economic growth -20 30
in the short term. 2004 2005 2006 2007 2008 2009 2010
On the other hand, we expect the government to avoid

stamping out the economic recovery which kicked off Source: CEIC, J. P. Morgan Economics.
only in August. In other words, we expect the
government to strike a balance between containing Figure 23: China: IP and PMI orders-to-inventory ratios
inflationary pressure and maintaining the underlying
China: IP and PMI orders to inventory ratios
economic growth. %3m/3m, saar New orders to %
Real IP
Hence, while a number of deep cyclical sectors which are inventory ratio (NBS)
40 150
very sensitive to the investment growth in China, such as 30
steel, aluminum, and heavy trucks, may take a hit in the 120
20
coming months, the risk of China’s overall economy
10 90
suffering a major economic slump is exaggerated, in our New orders to
0
view. inventory ratio (Markit)
-10 60
Leading indicators suggest that China’s economy has 2004 2005 2006 2007 2008 2009 2010
been on a steady upturn since 3Q FY10: China’s NBS
manufacturing PMI continued to rise for three
consecutive months in August, September and October, Source: CEIC, J. P. Morgan economics.
from 51.2 in July to 54.7 in October.
Moreover, regarding China’s underlying economic
NBS manufacturing PMI now firmly stays above the growth, we believe the steady pick-up in growth
expansionary threshold of 50. This suggests that the momentum will come from the solid expansion in
economy’s mid-year downshift is mostly over, and
domestic demand. First, private consumption maintains
confirms our view that China’s economic growth
the robust growth due to the government’s dedicated
bottomed out in 3Q FY10.
measures to boost households’ disposable income. This
Figure 21: China—Manufacturing PMIs trend has been reflected in the sequentially improving
readings in retail sales.
China: manufacturing PMIs
NBS PMI
Index , sa
Figure 24: China—Retail sales growth
60
%oy a %3m/3m, saar
50 25 35
%oya %3m/3m, saar
Markit PMI 20 25
40
15 15
30
10 5
2004 2005 2006 2007 2008 2009 2010
5 -5
2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: CEIC, J. P. Morgan Economics.
Source: CEIC, J. P. Morgan economics.
13
(852) 2800-8511 24 November 2010
Secondly, on the investment front, overall FAI growth (c) Manufacturing FAI should remain steady as global
should remain fairly resilient in 2011 (rising about 20- demand growth could reaccelerate in mid-2011.
25%) because of:
Table 3: China’s FAI growth
(a) the expected sharp increase in public economic
housing investment; China FAI (RmbMM) FAI growth rate (%oya)
2010E 24,028,304 23.8
(b) our belief that a new round of investment projects 2011E 28,549,327 18.8
will kick-off by the end of this year and early next year. Source: J. P. Morgan Economics team estimates.
FY11 marks the first year of China’s 12th Five-Year
Plan, and the first three years of China’s Five-Year Plans Third, against the backdrop of the economic recovery in
are normally characterized by rising fixed asset western countries on QE2 measures, we could see a
investment growth; rising momentum in China’s net trade as of 2H11, which
could give China’s economic growth an additional boost.
Table 4: Global economic outlook
Real GDP (% over a year ago) Real GDP (% over previous period, saar)
2009 2010 2011 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
The Americas
United States -2.6 2.7 2.5 1.7 2.0 2.5 2.0 3.0 3.0 4.0
Latin America -2.4 5.7 4.1 9.1 2.4 3.1 4.4 6.0 3.4 4.2
Asia/Pacific
Japan -5.3 3.5 1.1 1.8 3.9 -1.5 0.5 1.5 1.8 2.0
Asia ex Janpan 5.6 8.9 7.2 7.2 5.5 7.1 7.5 7.5 7.7 7.7
China 9.1 10.0 9.0 7.2 8.1 8.7 9.5 9.1 9.3 9.3
India 7.4 8.3 8.5 8.5 8.0 8.9 8.0 8.5 8.6 8.9
Europe
Euro area -4.0 1.7 1.6 3.9 1.5 1.5 1.0 1.5 1.8 2.0
Germany -4.7 3.5 2.6 9.5 2.8 2.5 2.0 2.0 2.0 2.0
France -2.5 1.6 1.6 2.7 1.4 1.5 1.5 1.0 2.0 2.0
Italy -5.1 1.0 1.3 1.9 0.7 1.0 1.5 1.0 2.0 2.0
Norway -1.2 1.6 2.4 1.9 3.7 2.5 2.0 2.0 2.5 2.5
United Kingdom -5.0 1.7 2.3 4.7 3.2 1.5 1.0 2.5 3.0 3.0
Emerging Europe -5.3 3.7 4.0 3.8 -1.0 5.4 4.0 4.3 4.6 4.7
Global -2.2 3.7 3.0 3.9 2.6 2.7 2.7 3.4 3.4 3.8
Developed markets -3.5 2.5 2.0 2.8 2.2 1.6 1.5 2.3 2.4 3.0
Emerging markets 1.3 6.9 5.7 7.0 3.7 5.7 6.1 6.5 6.0 6.2
Source: J. P. Morgan.
Hence, we maintain our view that China’s overall Table 6: China’s economic growth drivers
economic growth will remain solid in FY11, with our China: Economic indicators
FY11 real GDP growth forecast at 9%.
Table 5: China’s real GDP growth 2010E 2011E
China’s real GDP growth - %q/q, saar China’s real GDP growth - %oya
10Q1 4.2 3.6 Real GDP, % change 10.0 9.0
10Q2 3.9 4.0 Consumption¹ 4.6 4.7
10Q3 2.4 3.8 Investment¹ 5.0 4.8
10Q4 2.6 3.3 Net trade¹ 0.4 -0.4
11Q1 2.7 2.9
Source: J. P. Morgan Economics team estimates.
11Q2 3.3 2.7
11Q3 3.4 3.0
11Q4 3.8 3.4 Meanwhile, given that the corporate profit growth
Source: J. P. Morgan estimates. normally follows that of the economic growth, the
economic growth recovery as of July has now translated
into steady upward revisions of consensus earnings
estimates for MSCI China for three consecutive months
since August.
Notably, the consensus FY10 and FY11 earnings

estimates for MSCI China were both increased by 1% in
14
(852) 2800-8511 24 November 2010
October, on top of the 2.6% and 1.6% upward revisions, due to possible concerns about the loss of jobs in the
respectively, in September. export sector. Should this be the case, it could be difficult
to fully sterilize the money inflows into China, even
Should the upward earnings revisions continue in the though the government could scale up its quantitative
coming months, Chinese equities’ performance should controls for liquidity management.
receive additional support.
The overall liquidity situation in China should stay loose
Figure 25: China—One-month consensus FY10 earnings estimate in November/December, despite the recent 50bp RRR
revisions for MSCI China increase. This is because the central bank’s liquidity
6.0% Consensus 1m earnings estimate revision withdrawal has been more than offset by a pickup in FX
4.0% inflows and seasonal outflows of government deposits
from the PBoC into banks.
2.0%
0.0% Our rates research team believes that the excess reserves
-2.0%
in the banking system, a barometer to gauge the overall
liquidity situation, would likely stay at an ample level of
-4.0%
around Rmb900 billion in November, before rising
-6.0%
FY10E consensus earnings revision further to Rmb2 trillion in early December.
-8.0% FY11E consensus earnings revision Figure 27: China’s excess reserves in the banking system
-10.0%
Rmb bn Excess Reserve
Feb/09 May /09 Aug/09 Nov /09 Feb/10 May /10 Aug/10 Nov /10
3000
Source: Bloomberg, J. P. Morgan. JPM forecasts
2500
Figure 26: China—Consensus earnings estimate revisions for 2000

MSCI China (EPS in Rmb)
1500
6.5
6 1000
2011
5.5 500
5
0
2010
4.5 Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09 Jul-10 Apr-11
4
Source: CEIC, J.P. Morgan Rates Research.
3.5
3
Meanwhile, the latest monetary supply growth data also
Feb/08 May /08 Aug/08 Nov /08 Feb/09 May /09 Aug/09 Nov /09 Feb/10 May /10 Aug/10 Nov /10 convey a similar message of improving overall liquidity
condition in China, with the M2 sequential trend growth
Source: Bloomberg, J. P. Morgan.
having accelerated from 13.4% 3m/3m saar in July to
22.2% in October. That said, with the expected monetary
(3) Liquidity situation still tightening, we believe we could see a moderation, but not
accommodative for equity performance a collapse, in M2 growth in coming months.
We hold our view that the liquidity situation is still
Figure 28: China—M2 sequential growth (%, 3m/3m saar)
accommodative for equity performance, despite the
50
current monetary tightening measures. This is because:
40
30
(1) China’s excess reserves in the banking system are
still ample 20
It is difficult for the government to fully sterilize the “hot 10
money” flowing into China on the back of QE2 in the US, 0

unless China decides to do a major currency revaluation. Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10
Our view on Rmb appreciation, however, is that the M2 grow th , % 3m/3m saar
Chinese government will continue to favor gradual
Source: CEIC, J. P. Morgan Economics.
appreciation rather than a big one-step Rmb appreciation
15
(852) 2800-8511 24 November 2010
(2) More capital flight into the equity markets from Figure 31: Monthly Rmb deposits and retail deposits
bond markets 3000 2000
Given rising inflation concerns and falling bond yields, 2500 1500
coupled with a perception of improving fundamentals in 2000 1000
the equity market, we have started to see a major trend of 1500 500
capital flight into the equity markets from bond markets 1000 0
in China. 500 -500
0 -1000
According to the latest statistics from Wind, domestic
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
mutual funds have diverted their capital from bond
investments to equity markets, with the percentage share Ov erall deposit (Rmb bn) Retail deposit (Rmb bn)
of total investments allocated to bond assets falling from Source: CEIC.

15.1% of total assets in 2Q this year to 13.7% in 3Q,
while the percentage share of total investments in stocks We believe the difference is a function of more margin
rose from 65.3% in 2Q to 73% in 3Q. deposits with brokers, i.e. more deposits are being
diverted to broker accounts ready to be invested in the
Figure 29: Mutual funds’ asset allocation to stocks and bonds (as equity markets. Indeed, in October, incremental margin
a percentage of total fund assets)
deposits for security trading are estimated to be around
% of total funds
Stock Bond Rmb600 billion, which are counted as M2 but not as
73.6 73.0
80.0
65.3
Rmb deposits.
60.0
(4) MSCI China’s valuations still
40.0
15.1
undemanding
12.1 13.7
20.0
MSCI China is among the worst-performing indices in
0.0
the EM market, underperforming MSCI EM by 3.7%
1Q10 2Q10 3Q10
YTD, due to the market’s concerns about monetary
Source: Wind. tightening and economic slowdown risks throughout
most of this year.
Figure 30: The bond market index
138 Notably, based on consensus EPS growth forecast of
136 24.8% for FY10, MSCI China is trading at a 15.0x
134
FY10E P/E, and 2.4x FY10E P/BV, versus the average
132
130
trailing P/E of 16.0x, and average trailing P/BV of 2.1x
128 since 2000.
126
3-Aug-10 17-Aug-10 31-Aug-10 14-Sep-10 28-Sep-10 12-Oct-10 26-Oct-10 9-Nov -10 With MSCI China’s earnings-based valuation now
ChinaBond Ex change Treasury Bo ChinaBond Interbank Aggregate
standing below the long-term historical average—an
undemanding level, in our view—we believe that the
Source: Bloomberg. market has already discounted a large part of the policy
tightening risks.
Notably, the Chinese stock market at current

(3) Deposits being diverted to stock markets undemanding valuations may actually turn out to be a
On back of the two-month stock rally since September 10, better investment channel than the property market and
we find that an increasing number of deposits in China the agricultural futures market.
are being diverted to Chinese equity markets.
In October, despite a month-on-month increase of

Rmb340 billion in M2, Rmb deposits merely recorded an
increase of Rmb176.9 billion, and retail deposits suffered
a decline of Rmb700.3 billion.
16
(852) 2800-8511 24 November 2010
Figure 32: MSCI China has underperformed MSCI EM by 3.7% Figure 35: J.P. Morgan and consensus Rmb forecasts
YTD 8.4
115
110
8.0
105
100
7.6
95
7.2 J.P.Morgan forecast: Consensus
90
85 6.8 end Dec 10: 6.60
80
6.4 end Mar 11: 6.50
1/Jan/10 1/Mar/10 1/May /10 1/Jul/10 1/Sep/10 1/Nov /10 J.P. Morgan
MSCI EM MSCI China
end Jun1: 6.40
6.0
Source: Bloomberg. Dec 04 Sep 06 May 08 Jan 10 Sep 11
Figure 33: MSCI China trailing P/E ratio
x
35 Figure 36: Monthly forex reserve accumulation, US$B
30 billion US$
Current=15.0x
25
+1 std dev = 20.6x
20 100
15
long term av g PE=16.0x (since y ear 2000) 80
10
60
-1 std dev = 11.4x 40
5
20
0
0
Nov /00 Nov /01 Nov /02 Nov /03 Nov /04 Nov /05 Nov /06 Nov /07 Nov /08 Nov /09 Nov /10
-20
Source: Bloomberg, J. P. Morgan. -40
03 04 05 06 07 08 09 10
Figure 34: MSCI China trailing P/BV ratio Source: CEIC, J.P. Morgan estimates.
5 x
Current=2.4x
4
3 +1 std dev = 2.8x

Sector views
long term av g PB=2.1x (since y ear 2000)
2 From a macro strategy perspective, we are overweight on:
1 (1) insurance which benefits from interest rate rises; (2)
-1 std dev = 1.4x
IT, which has been a big laggard this year, and which
0
stands to benefit from the expected rising momentum in
Nov /00 Nov /01 Nov /02 Nov /03 Nov /04 Nov /05 Nov /06 Nov /07 Nov /08 Nov /09 Nov /10
China’s exports in 2H11 on the improved economic
Source: Bloomberg, J. P. Morgan. outlook in western countries; (3) consumer, especially
luxury consumption and menswear names, as well as
(5) Rmb appreciation expectations make retailers; (4) service industries, such as IT outsourcing,
healthcare, auto after sales service, and education, which
HK-listed Chinese stocks attractive can normally pass on the inflationary pressure, and which
assets for global investors seeking Rmb stand to benefit from more policy support in the coming
assets 12th Five-Year Plan in China; (5) economic-housing
With the rising attraction of Rmb assets on the back of beneficiaries such as BBMG; (6) heavy machinery, such
Rmb appreciation expectations, and with the expected as coal mining machinery which has suffered from a
significant liquidity inflows into EM due to QE2 in correction over the past month; (7) nuclear power
developed economies, we believe Hong Kong-listed equipment, natural gas, and water treatment; (8) telecom
China stocks, at their current attractive valuations, equipment, which stands to benefit from China’s
especially after the under-performance of MSCI China expected big investment in the telecom sector in 12th
this year, represent a collection of attractive Rmb assets Five-Year Plan; (9) banks, which tend to outperform in a
for global investors. rate rise cycle; and (10) China commodities, such as
cement, whose demand is driven by domestic end
demand rather than by global demand.
17
(852) 2800-8511 24 November 2010
We are overweight on: If rising interest rates prove to be sustainable in the

longer term, insurers can increase investment yield
(1) Insurance assumptions used in deriving EV and NBV. Chinese
Insurers benefit from interest rate rises insurers have had a history of marking to market their
The investment environment has proved to be very investment return assumptions. We include the
challenging for insurers for most of 2010 with bond sensitivity analysis here despite the fact that we generally
yields trending lower since the start of the year and a believe an upward revision is unlikely for 2010,
delay in deposit rate rises. Fortunes have been reversed especially for China Life and Ping An, as they have
with PBOC finally deciding to raise one-year lending already assumed more aggressive investment yield
rates and time deposit rates by 25bp on October 20, 2010. assumptions than have peers. We note that CPIC is likely
This was the first increase since the last interest rate cut to record the most uplift in the value of its existing
in December 2008. As a result of this unexpected interest business, while Taiping Life is likely to see the highest
rate rise, bond yields have also trended upward increase in the value of new businesses. The slight
substantially with the 10-year government bond yield drawback in rising interest rates is that bond portfolios
now ~50bp higher than before. suffer from marked-to-market losses, adversely
impacting book value and EV.
Rising interest rates are positive for insurers, as insurers
can invest new money from insurance sales and old We maintain our positive view on the insurance sector
money from maturing fixed income investments at higher given the improving investment outlook driven by a
returns. Bonds account for 54% of total investments for combination of rising interest rates and stronger equity
Chinese insurers, while deposits account for another 33%. market performance.
The returns on bond and deposit have trended lower
Our top pick within this sector remains Ping An-A due to
since 2009 and the recent rate increases should give the
its profitable life insurance franchise as well as strong
much needed uplift to insurers.
growth in other business operations.
The immediate impact of the interest rate rise should be
Figure 37: Government bond yields have trended upward since
an increase in the return on deposits given the automatic the unexpected interest rate rise by PBOC in October
re-pricing mechanism on some of the negotiable deposits. 4.5
We estimate a 25bp increase in interest rates would result 4.0
in approximately a 0.5% increase in net income. For the 3.5
impact on bond investments, the magnitude of 3.0
improvement would depend on the duration of the bond 2.5
portfolio. Insurers with shorter-duration bond holdings 2.0
should benefit more as bond yields increase. We estimate 1.5
Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
a 25bp increase in bond yield would result in a 0.2% to
5-year 10-year
0.5% increase in net income for large life insurers. China
Source: CEIC.
Life is likely to record less of an uplift, according to our
estimates, than its closest peers given its longer bond
duration and hence lower reinvestment frequency.
Figure 38: Recurrent return on deposits has trended lower since Figure 39: Recurrent return on bond investments has trended
2009 for China Life lower in 1H10 because of lower bond yields
7.0 7.0 4.8 5.0
6.0 6.0 4.6 4.5
5.0 5.0 4.4 4.0
4.0 4.2 3.5
4.0
3.0 4.0 3.0
3.0 2.0 3.8 2.5
2.0 1.0
3.6 2.0
1.0 0.0
Jul-06 Dec-06Jun-07 Dec-07Jun-08Dec-08Jun-09Dec-09Jun-10
Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
China Life (%) 10-y r gov t bond y ield (RHS)
5-y ear deposit rate (%) Return on deposits (%) (RHS)
Source: CEIC, China Life. Note: We use China Life as a proxy for the insurance sector. Source: CEIC, China Life. Note: We use China Life as a proxy for the insurance sector.
18
(852) 2800-8511 24 November 2010
Figure 40: Impact of a 25bp increase in investment yield assumption on insurers’ actuarial data
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
China Life Ping An CPIC Taiping Life
Improv ement in v alue of in-force business Improv ement in NBV Improv ement in EV
Source: Company data. Note: Based on 1H10 actuarial disclosures, except for Taiping Life (based on 2009 data).
Table 7: Valuation summary for Chinese insurers

B'berg Price PT P/E P/BV P/EV Implied NBM Rating Upside
C'cy code 23-Nov-10 Dec-11 FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E
China Life-H HK$ 2628 HK 33.45 37 23.3 19.1 3.3 2.9 2.5 2.2 27.4 21.8 N 11%
China Life-A Rmb 602628 CH 22.35 27 18.2 14.9 2.6 2.2 2.0 1.7 20.1 15.5 N 21%
Ping An-H HK$ 2318 HK 89.35 105 33.6 24.7 4.9 4.1 2.9 2.4 25.2 18.8 OW 18%
Ping An-A Rmb 601318 CH 56.26 76 24.7 18.2 3.6 3.1 2.2 1.8 17 12 OW 35%
CPIC-H HK$ 2601 HK 31.25 40 30.2 21.8 2.7 2.5 1.9 1.7 22.2 16.6 OW 28%
CPIC-A Rmb 601601 CH 22.31 29 25.3 18.2 2.2 2.0 1.6 1.4 18.4 13.4 N 30%
PICC HK$ 2328 HK 11.68 7.2 30.2 26.4 4.2 3.6 n.a. n.a. n.a. n.a. UW -38%
CTIH HK$ 966 HK 27.6 36 43.6 30.1 3.9 3.4 3.0 2.4 37.1 24.5 OW 30%
(2) IT sector In the consumer sector, we believe the menswear,

retailers and luxury consumer sub-segments offer the
China’s IT sector is the fourth-worst-performing sector best growth profile.
so far this year, with the sector rising only by 2.6%
versus a rise of 5.7% for MSCI China. (A) Menswear
Against the backdrop of a global economic recovery, we We have long held the view that the menswear segment
could see rising momentum in 2H FY11. This, together will show strong growth potential in the coming three to
with solid domestic demand, could translate into IT five years.
sector’s out-performance from here. We believe the menswear segment, which is still not well
Within this space, we like Digital China, Vanceinfo developed in China in terms of menswear consumption
(VIT)—a diversified IT services company, with quality per capita (US$291 p.a. in China, compared with
management and strong execution capabilities—and US$1,175 p.a. in the US and US$1,489 p.a. in Europe),
Lenovo, which should benefit from the expected has significant room for growth, as Chinese men become
recovery in the US as well as in China. more brand and fashion conscious, and start to spend
more on purchasing branded menswear.
(3) Consumer (especially menswear, As noted before, according to Euromonitor, menswear
retailers and luxury names) could record a 17.7% CAGR in its retail sales in China
As highlighted in our previous strategy notes, we believe from 2006 to 2011, notably higher than women’s wear
consumer names offer the best adjusted risk-reward ratio. CAGR of 11.7%, children wear CAGR of 9.2%, and the
The combined effects of the ongoing re-rating and overall apparel market’s CAGR of 14.2%.
consistent earnings growth amid the economic upturns
and downturns should bring about notable rewards for
the long-term investors of quality consumer stocks in
China.
19
(852) 2800-8511 24 November 2010
Table 8: Different apparel segments’ CAGR of retail sales in Table 9: Top five countries in terms of number of wealthy people
China (2009)
CAGR (2006-2011) Country Number of people growth
Total apparel market 14.2% (000 people)
Menswear 17.7% 1 USA 2,870 16.5%
Womenswear 11.7% 2 Japan 1,650 20.8%
Children wear 9.2% 3 Germany 860 6.4%
Source: Euromonitor. 4 China 477 31%
5 UK 452 8%
Source: ACMR.
In light of the strong secular growth potential, we believe
the menswear segment could represent a good investment
Table 10: China—Disposable income per capita of different
opportunity in China. Leading companies in China’s economic classes (Rmb)
menswear sector, such as China Lilang and Trinity, could
benefit from such a secular growth trend. Low Lower Middle Upper High Highest
income middle income middle income income
income income
(B) Retailers 2000 3634 4624 5898 7487 9434 13311
Normally, retailers, as a middlemen, tend to benefit from 2005 4885 6711 9190 12603 17203 28773
rising inflation. Companies such as Intime Department 2008 7383 10196 13984 19254 26250 43614
CAGR over 2000-2008 9.20% 10.40% 11.40% 12.50% 13.60% 16.00%
Store and Belle should benefit.
Source: ACMR.
(C) Luxury items

We believe that the consumption of luxury items is The pattern of disposable income growth in China has
quickly taking off in China’s tier-one cities before been widespread as the benefits of economic success
spreading to tier-two and tier-three cities, which could have trickled down to all classes. The above table shows
prove to be a powerful trend to last in the next five years. how different economic classes fared from 2000 to 2008,
and a distinct trend is that the higher the class, the higher
Rising momentum of wealth accumulation: China’s the CAGR of disposable income over the period.
rich is getting richer
According to Mckinsey research, China is expected to The low-income group’s per capita disposable income
have more than 4 million wealthy households (annual grew from Rmb3,634 in 2000 to Rmb7,363 in 2008,
income of over Rmb250,000 p.a.) by 2015. This should translating into a 9% CAGR over the period. In contrast,
put China in fourth place in the global standings based on the highest income class grew from Rmb13,311 to
the number of wealthy households, behind the US, Japan, Rmb43,614 over the period, translating into a CAGR of
and the United Kingdom. over 16%, far outpacing the growth of the low-income
group.
At present the wealthy account for less than 1% of urban
Chinese households, but this demographic segment is
growing at 16% per annum. Notably, about half of Figure 41 shows that with higher growth rates, the
China’s wealthy consumers were not classified as such affluent section of China’s population has continued to
four years ago, and more than half of those who will be swell, and the number of wealthy families with assets
wealthy in the next six years are not wealthy today. worth more than US$1 million has grown. From 2003 to
2009, the number of these wealthy families increased
At present, geographical patterns characterize this
from 141,000 to 453,000, representing a CAGR of 21%
significant accumulation of wealth and growing luxury
consumption in China. We find that the highest over the period.
concentration of wealthy families is in the eastern and
coastal regions of China, i.e. areas that have historically Going forward, we forecast that this number will increase
led the country in terms of opening up to the outside further, reaching 697,000 households by 2012,
world and economic reform. Notably, around 30% of translating into a CAGR of 15% from 2009 to 2012E.
these wealthy families are located in China’s four largest
cities, Beijing, Shanghai, Shenzhen and Guangzhou.
20
(852) 2800-8511 24 November 2010
Figure 41: China—Number of households with assets above China's luxury market: Soon-to-be world’s largest
US$1 million China has experienced a rapid expansion in consumer
000 households affordability since 1990s. Consumers have grown in
800 affluence and more importantly become more
697 sophisticated and knowledgeable of the Western
700
609 consumption model.
600 529
500 437 453 Notably, many luxury brands have already positioned
417
themselves to tap the significant growth potential of
400
305 Chinese consumers, with Louis Vuitton, Bally, Gucci and
300 223
Ferragamo being among the first wave of retailers to
179 open outlets in China back in the mid-1990s. China’s
200 141
luxury consumers will undoubtedly constitute a central
100 component of the long-term growth strategies of these
0 luxury brands, in our view.
2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E
Source: ACMR. Chinese luxury market’s potential—Highlights

1. Sales of luxury goods grew by 12% in 2009 to US$9.6
Typically, entrepreneurs and corporate leaders, China’s billion, accounting for 27.5% of global luxury sales.
upper crust, have been growing in number and in their
level of wealth. According to Hurun Research, in 2009, 2. The Chinese Academy of Social Sciences has estimated
Chinese individuals with a net worth of €1 million that by 2015, China will be the largest luxury market
totaled around 875,000 with a 6.1% Y/Y growth. There globally, overtaking Japan.
were 55,000 individuals with a net worth of over €10 3. At least 50% of Hong Kong’s and Macau’s luxury
million, with an even higher growth of 7.8% Y/Y. In business is generated by PRC customers.
2009, there were 1,900 individuals worth over €100
million and over 300 billionaires in China. A key trend 4. According to the Hurun Report, from 2008 to 2009, the
among China’s millionaires is they are typically 15 years number of people in China worth over Rmb10 million
younger than their western counterparts and their wealth grew by 6.1% to 875,000, with most born after 1970; the
is growing more rapidly. number of people worth over Rmb100 million grew by
7.8% to 55,000, with most of them born after 1966. We
Figure 42: Size of China’s rich and super-rich believe the Hurun Report may have understated the
number of rich people and their wealth, because
traditional Chinese culture promotes the virtues of
modesty, and we believe the rich tend to keep a low
profile and understate their wealth.
5. The ratio of males to females of this new wealthy class is
skewed heavily towards males at a ratio of 7 to 3.
Figure 43: Luxury point-of-sale openings in China, 2008
Source: Hurun Rich Report.

Source: Annual reports of companies, company websites, discussion with public relations
departments of luxury brands, BCGs direct calls to 1051 retail outlets, BCG analysis.
21
(852) 2800-8511 24 November 2010
China is expected to surpass Japan as the world’s largest Figure 44: Geographic evolution of China’s wealthy households
luxury market in the next five to seven years. Over the (MM)
past two decades, spurred by the rapid growth of the
number of affluent Chinese families, global luxury
brands have been investing heavily to maximize returns
on this trend. This is reflected in the strong growth
experienced by the size of China’s luxury retail sector
from 2005 to 2009, with the number of luxury points of
sales doubling in that period.
Luxury consumption taking off in China’s interior

areas
The acceleration of economic growth in China’s tier-two
and tier-three cities, and China’s interior regions such as Source: Mckinsey Global Institute, Insights China by Mckinsey – 2005 Chinese Consumer
western and central China, is beginning to have a Survey. Note: This geographic evolution of the location of China’s wealthy consumers will
be a defining trait of the future expansion of the country’s luxury sector, supported by a
dramatic impact on the development of luxury more even distribution of wealth over the whole of China.
consumption in China.
According to Wealthy Chinese Consumer Survey, in
As affluence ripples through the country, the importance
2008, there were an estimated 1.6 million wealthy
of these previously untapped regions and cities has
households in China, with 35% of them located outside
grown significantly. According to a study by Bain, tier-1 and tier-2 cities. In 2015, there will be an estimated
consumers in tier-two and three cities accounted for more 4.4 million wealthy households, a CAGR of 15.54% over
than 60% of the growth in China’s luxury consumers in the period, with 40.9% of these families located outside
2008 and 2009. China has approximately 150 cities with China’s tier-1 and tier-2 cities. This trend is a clear
population exceeding one million residents and indication of the geographical evolution occurring among
consumers in these cities are increasingly China’s wealthy classes, with a much higher
indistinguishable from those in major cities. representation from China’s tier-two and tier-three cities,
and from China’s western and central provinces.
(4) Inflation beneficiaries

We also like inflation beneficiaries, such as retailers,
which are capable of passing on the rising costs to end
customers, as well as certain upstream commodities, such
as coking coal and gold which are perceived as an
inflationary hedge.
Indeed, as shown in Figure 46, leading companies in

these sectors all outperformed the MSCI-China index
during the past inflation up-cycle from January 2007 to
October 2007.
22
(852) 2800-8511 24 November 2010
Figure 45: Inflationary beneficiaries’ performance during the past inflation upcyle
560 P A RKSON CHINA COA L YA NZHOU COA L ZHA OJIN M INING
CHINA LIFE P ING A N INSURA NCE ZIJIN M INING M SCI CHINA

510
460
410
360
310
260
210
160
110
60
Jan/07 Mar/07 May /07 Jul/07 Sep/07 Nov /07 Jan/08 Mar/08
Source: Bloomberg.
(5) Banks costs tends to lag that in lending yield typically,

unless the rate increases are significantly asymmetric
We believe banks will be winners in a mild inflationary in favor of time deposit rates.
environment, as higher inflationary pressure tends to
trigger more interest rate rises down the road. In general, • In the early stage of a rate increase cycle, in
as been proven in the previous rate cycle, a rising-rate particular, the NIM expansion was also driven by the
environment is positive for Chinese banks from two repricing gap as Chinese banks tend to be more asset
aspects: (1) margin story as banks benefit from widening sensitive, namely faster repricing in assets than
basic banking spread due to large existence of demand funding. This also helps NIM expansion.
deposits, as well as better credit pricing power; and (2) • Meanwhile, when rates move up, typically they
asset quality implications from a strong economy. come amid overall credit tightening in view of
strong economy. A tighter credit supply also
Figure 46: Banks outperformed MSCI China in a rising-interest- improves banks’ credit pricing power, which is
rate environment
positive for effective loan yield enhancement. Such
tightening also typically leads to a market rate spike
ahead of a benchmark policy rate movement, which
is also positive for banks’ treasury spread in their
bonds portfolio and interbank assets. This may still
apply in the current rate cycle.
• Lastly, implicitly while funding costs may still move
up, if an increase in rates is based on strong
economy, typically they will display a strong
correlation with the equity market performance. This
Source: Bloomberg, J.P. Morgan Economics. Note: H-share banks only include the period will lead to favorable deposit mix changes as more
since when BoComm was listed in late June 2005. retail investors channel their savings into the equity
market. This mitigates actual funding costs’ pickup
• In most cases, interest rate increases only apply to indeed, which is also positive for NIM.
time deposits, while demand deposits rarely are
• Lastly, typically while rate increases reflect inflation
subject to rate movements. Given that the percentage
outlook, they also implicitly imply a strong
of demand deposits is significant (at over 45% in
economy. We believe the underlying economic
most listed banks), the pickup in average deposit
23
(852) 2800-8511 24 November 2010
outlook remains strong. This has very positive

implications for asset quality, which could help
boost confidence in next year’s earnings outlook.
Figure 47: Banks’ NIM trend in view of potential interest rate rises
3.20% 3.17%
3.02%
3.00% 2.93% 2.85% 2.95% 2.71% 2.80%
2.80% 2.66% 2.91%2.99%
2.56% 2.63%
2.60%
2.42%
2.40% 2.52% 2.55%
2.25% 2.42% 2.48%
2.33%
2.20% 2.24% 2.27%
2.00%
2004 2005 2006 2007 2008 1H09 2H09 1H10 2H10E 2011E 2012E
Medium JSBs Big state-ow ned
Source: Company data, J.P. Morgan estimates.
We, thus, argue that inflation is less of an issue as long

as the underlying macroeconomic trend remains intact.
Banks tend to perform better in an inflationary cycle
than in a deflationary cycle.
As shown in Table 11, the positive earnings impact from

a 25bp interest rate increase will be in most cases about
3%-4% additional earnings growth in 2011. Our banking
team has factored in its models two more rate increases
in 2011 and another two in 2012.
24
(852) 2800-8511 24 November 2010
Table 11: Sensitivity analysis of banks’ earnings for every 27bp rate increase
ABC ICBC CCB BOC BoComm CMB Citic Minsheng Huaxia SPDB SZDB Average.
Lending yield impact 24 24 24 21 24 23 23 25 25 25 25 24
Loan as % of avg. assets 49% 49% 51% 55% 54% 59% 59% 57% 50% 56% 59% 55%
Interbank yield chg 25 25 25 18 25 25 25 30 30 30 30 26

Interbank as % of assets 5% 5% 5% 9% 7% 10% 11% 13% 28% 13% 13% 11%
Investment yield 10 10 10 10 10 10 10 15 15 15 15 12
Invstment as % of assets 28% 28% 26% 20% 23% 18% 18% 13% 10% 16% 16% 19%
Asset yield chg 15.9 15.9 16.3 15.2 17.1 18.1 18.3 19.8 22.0 20.1 20.8 18.4
Rmb demand as % of total deposit 53% 49% 53% 39% 48% 54% 46% 48% 45% 51% 31% 47%
Rmb time as % of total deposits 42% 46% 43% 43% 47% 41% 49% 51% 55% 48% 69% 49%
Unaffected (FX deposits etc) 5% 5% 4% 18% 5% 5% 5% 1% 0% 1% 1% 4%
chg in total deposits costs 10 11 11 11 12 10 12 13 14 12 17 12
Deposits as % of funding liabilities 91% 91% 91% 81% 80% 84% 84% 86% 73% 86% 85% 84%
Interbank cost 15 15 15 20 20 20 15 30 35 30 35 24
Interbank as % of funding liabilities 8% 8% 8% 18% 19% 15% 15% 13% 26% 13% 13% 15%
Debt cost 5 5 5 5 5 5 5 10 10 10 12 7
LT debt as % funding liabilities 1% 1% 1% 0% 1% 1% 1% 1% 1% 1% 2% 1%
Funding costs chg 10.8 11.7 11.1 12.3 13.2 11.5 12.4 14.9 19.1 14.2 19.0 13.8
Impact on net interest spread 5.1 4.3 5.2 2.9 3.9 6.6 5.9 4.8 3.0 5.9 1.8 4.5
11E avg. IEAs 11,102 14,456 11,528 10,967 4,113 2,639 2,226 1,914 1,136 2,171 767 51,917
11E avg. IBLs 10,394 13,512 10,860 10,205 3,746 2,424 2,141 1,788 1,042 1,902 747 48,368
Earning impact (Rmb mn) 4,811 5,445 5,051 3,105 1,562 1,485 1,071 836 387 1,254 131 20,327
FY10E net income 128,645 163,783 139,641 101,937 39,925 26,190 34,181 27,172 11,355 26,923 8,896 580,004
Impact to earnings growth 3.7% 3.3% 3.6% 3.0% 3.9% 5.7% 3.1% 3.1% 3.4% 4.7% 1.5% 3.5%
Source: Company reports. J.P. Morgan forecast.
We recommend that investors accumulate “higher-beta” Figure 48: High base of student population (millions)
medium-sized banks, which should benefit more from 1600 1328
rising rates, given: (1) better NIM expansion in view of
1200
their higher L/D ratio and faster re-pricing, as well as
more SME loans; and (2) reduced concerns about asset 800
quality which depressed their valuation more in periods 304
400 201
of economic uncertainty. Our current mid-cap bank top 56 20 19
picks include Citic-H and Minsheng-H, and our large-cap 0
top pick is ICBC-H. Population K-12 Students College Students
China US
(6) Service industries such as IT
Source: U.S. National Center for Education Statistics; IDC, NSBC. All data are for 2008.
outsourcing, healthcare, auto after sales
service and education An average Chinese family spends 3.8% of its disposal
Education: Rising demand for education due to income on education vs. 2.1% for a US family. As more
China’s favorable demographics and more Chinese middle-class families become affluent
with higher disposable incomes, the demand for quality
China has one of the largest addressable student
education is likely to increase as well. The spending on
populations in the world. In 2008, China had a much
education in China is expected to grow at a CAGR of
larger base of 201 million K-12 students vs. 56 million
20.7% from 2008-2013, according to IDC.
students in the US. For college students, China had 20
million students vs. 19 million in the US in 2008 (see
We believe XRC TAL Education (XRS US) and New
Figure 48). China also has a high proportion of young
Oriental Education (EDU US) will benefit from the rising
people in its population (50% population is in the 5-39
demand for quality education service in China.
year old age group); this large demographic should
continue to support long-term growth in the post-
secondary career enhancement market.
25
(852) 2800-8511 24 November 2010
IT outsourcing
We like Chinese IT outsourcing service firms, because Figure 50: IT spending as a percentage of GDP
we find the sustained growth of China’s IT services 2.5
industry has been driven by a number of global factors
2
that are providing momentum for the industry’s continual
expansion: (1) diversifying risks from India as global 1.5
companies look to shift some portion of their offshoring 2.3
1
budgets away from India; (2) offshoring in China as a 1.5
part of global companies’ China business development 0.5 1
strategy, building on an already established presence in 0.2
0
China; (3) cultural proximately to Japan, Korea and other UK US Japan China
Asian countries opening up opportunities; and (4) the
emergence of Hong Kong and Singapore as corporate Source: IDC, IMF.
hubs, driving up near-shore demand.
Going forward, the sustained development of China’s IT
Figure 49: Global IT services offshoring to China outsourcing industry will be characterized by three major
8 growth themes: (1) strong government support; (2)
7 2009-2014E CAGR of 22.4% expansion to tier-2 cities; and (3) growing M&A activity,
6 in our view.
5
4 7.6
3 6.3
We like VanceInfo Technologies within this segment as
5 we believe it has one of the best management teams in
2 3.3 4
2.4 2.8 the China IT outsourcing space, in view of: (1) good
1
0 corporate structure to support growth and the company
2008 2009 2010E 2011E 2012E 2013E 2014E targets to double headcount to 20,000 over the next two-
Source: IDC, J.P. Morgan estimates. Note: Figures denote outsourced IT spending by
three years; (2) strategically expanding into other
global companies to Chinese IT services companies. industry verticals, such as finance and transportation; and
(3) good experience in working with US/Europe clients -
Notably, on the domestic front there is a growing trend of potentially diverting dollars from India to VIT; and (4)
increasing domestic demand for further expansion of the focus on organic growth rather than acquisitions.
industry. We are seeing rising demand from domestic
companies as they upgrade their IT and operational Auto after sales service
infrastructure as they aspire to become world-class global We believe China’s auto service industry represents an
competitors in terms of product offering and customer attractive investment story. First, we believe China’s car
experience. In addition, government backing for IT after-sales market has significant growth potential
services is mounting, with central and local governments because: (1) the country’s passenger vehicles fleet should
investing in developing nationwide infrastructure for see a major expansion in coming years; (2) the share of
transportation, healthcare, and education which include after-sales revenue as a percentage of the dealerships’
considerable spending on technology and IT spending. total revenue is rather low compared with that of mature
markets, and is set for major expansion with the aging of
That said, historically China’s investment into the IT the passenger vehicles fleet in coming years.
sector has lagged behind that of more developed nations.
As a percentage of GDP, China spent only 0.2% in 2009, Passenger vehicle fleet should see a major expansion in
compared with 2.3%, 1.5% and 1% for the UK, the US,
coming years
and Japan, respectively. Using the banking industry as an
China’s passenger vehicle fleet has experienced a strong
indicator of China’s comparatively low level of IT
growth over the past decade. In 2000, there were
spending, while in terms of assets, China’s banking
approximately 8.5 million vehicles. By 2009, it was 48.5
industry is similar in size to that of the US, in 2008 the
US banking industry invested 10x more into IT than did million, representing a 21% CAGR over the period. We
China’s banking industry. We see this as evidence of the forecast this growth to continue on the rising upward
embedded growth potential of China’s IT outsourcing trend. From an estimated 60.69 million in 2010, we
industry and the magnitude of the “catch-up” China project China’s passenger vehicle fleet to grow to 217
needs to address. million by 2020.
26
(852) 2800-8511 24 November 2010
Table 12: China’s passenger vehicle fleet expansion need of maintenance and repair should grow significantly
Year No of cars on the road from here.
(MM units)
2000 8.54 Compared to the mature US market where new car sales
2001 9.94
2002 12.02 comprise typically 57-59% of the total revenue for
2003 14.79 dealerships, we find that new car sales tend to account
2004 17.36 for 85-90% of Chinese four-in-one dealerships’ revenue,
2005 21.32
2006 26.20 indicating strong growth potential for China’s auto
2007 31.96 services industry in the years to come. This should be
2008 38.39 positive for China’s auto after-sales companies such as
2009 48.45
2010E 60.69
Zhongsheng Group Holdings.
2011E 74.06
2012E 89.09 We are negative on mid-stream
2013E 104.54
2014E 120.93 processing industries, paper, capital
2015E 138.36 goods, IPPs, telcos, toll roads and wind-
2016E 156.76
2017E 173.08 power equipment
2018E 187.99
2019E 202.60
2020E 217.00 We are negative on:
(1) Mid-stream processing industries, such as steel and
Figure 51: China's passenger vehicle flee expansion (MM units) aluminum, given the unfavorable combination of falling
250 demand on the back of the monetary tightening but rising
raw material costs;
200
(2) Paper on peaking margin concerns;
150
(3) Capital goods plays, such as heavy truck sector due to
the negative impact from the monetary tightening;
100 (4) IPPs and refineries, on the possible delay of

electricity tariff and refinery product price hikes due to
the government’s concerns on the inflation front;
50
(5) Certain industrials such as wind power equipment on

0 possible oversupply concerns.
2000 2002 2004 2006 2008 2010E 2012E 2014E 2016E 2018E 2020E
In sharp contrast to the mature markets such as the US,

China’s after-sales market is still at an early stage of
development, and with the gradual aging of the passenger
vehicle fleet, we should see China’s after-sales market
enjoying strong growth in coming years. Normally,
demand for after-sales services rises the most once
passenger vehicles enter the fifth year of their service
life.
According to ACMR, the percentage of passenger

vehicles that have been in use for more than three years
in China will rise from approximately 50% in 2008 to
66% by 2012, indicating that the number of vehicles in
27
(852) 2800-8511 24 November 2010
China Model Portfolio (CMP) Our telecom analyst Lucy Liu, who has been positive on
adjustments Unicom, noted the following three positive drivers for
Unicom:
As of November 19, 2010, our model portfolio had risen (1) A pickup of 3G monthly subscribers over coming
by 18.2% since January 1, 2010, versus a 5.7% gain in months coupled with stable 3G ARPU.
MSCI China during the same period. Since December 31,
2004, our model portfolio has outperformed MSCI China We think the market still pretty much focuses on the top-
by 126.5%. line prospect of the company, i.e., 3G monthly subs and
3G ARPU. Near-term earnings might be less indicative
Over the past month, among others, our model portfolio
given the potentially accelerated 3G handset subsidies in
has been helped by Geely, Zhaojin Mining, Glorious
coming quarters (one-off expense at the beginning of the
Property, Agile Property, and CNOOC, which rose by contract), which would result in a sharper V-shaped
16.2%, 15.7%, 11.3%, 10.6% and 10.6%, respectively. growth of the bottom line. A key question for such a
On the other hand, detractors from performance included market share challenger is whether the opex in the near
China Merchants Bank-A, China Resources Power, Bank term could successfully translate into top-line growth. In
of Communications, and China Railway Group, which this regard, we remain confident in the pick-up of
dropped by 13.8%, 9.7%, 9.4%, and 8.6%, respectively. Unicom's monthly 3G subs over coming months, which
we believe will be driven by:
Figure 52: Since 31 December 2004, our CMP has outperformed
MSCI China by 126.5% a) The handset supply issue of iPhone 4, Lephone and
500
other smartphones, which partly dampened 3G subs
450 growth in the past quarter, should be resolved fairly
JPM China Portfolio
400 quickly, according to the company. The recent launch of
the iconic smartphone models such as Samsung Galaxy S
350
and Nokia 7C should further enhance the value chain
300 advantage of WCDMA.
250
200
b) Further improvement in handset distribution. Unicom
signed an agreement with Bestbuy in the past month for
150
WCDMA handset sales, similar to the agreement signed
100 with Suning previously. We believe a further leverage of
MSCI China
50 public distribution channel is important for the company

Dec-04 Jul-05 Feb-06 Sep-06 Apr-07 Nov -07 Jun-08 Jan-09 Aug-09 Mar-10 Oct-10 to reach out to the mass market.
Source: Bloomberg and J. P. Morgan.
c) With the above two points fostering the gross addition
Model portfolio adjustments of 3G subs, we expect subscriber churn will be better
managed by the company in light of the increasing
Switching from China Mobile back to Unicom contribution of contract customers than in the past. The
In September, we took profit on Unicom and China contribution of contract customers amounted to 19% of
Telecom before switching to China Mobile, as a tactical 3G net adds in 3Q, up from 5% in 1H10.
trade to play the short-term catch-up for large-cap blue
chips after the underperformance over the China index Moreover, we see further upside to the market
for most part of the year as global funds moved to snap expectation of 3G ARPU, which has surprised the market
up large-cap laggards in the China universe. positively in the past quarters. We believe the take-up of
smartphone adoption and higher contribution of contract
Now that the tactical trade is over, and China Unicom’s customers will help stabilize ARPU further.
share price has declined by 8.5% from October 20 to
November 19, underperforming MSCI China index by 2) Free cash flow to largely turn around in the next one-
7.1%, we see more value in Unicom. As a result, we cut two quarters.
our weight for China Mobile from 10% to 2%, and add
Unicom back into our model portfolio with a weight of We expect CU’s FCF to turn positive as early as in 1Q11
5%. in light of its improving operating cash flow and the
28
(852) 2800-8511 24 November 2010
stabilization/slight decline in capex next year. We expect

a strong recovery in FCF profile over coming years to
showcase the improvement in operations and alleviate
investor concerns about near-term earnings.
3) Undemanding valuation
Based on our estimates, CU is currently trading at 1.1x

P/B and 4.3x 2011E EV/EBITDA, despite a relatively
high P/E ratio of 29x due to the near-term opex/capex
impact on the bottom line. It is inexpensive compared to
the valuations of regional telecom peers across most of
the valuation metrics. Our price target implies 2011E
EV/EBITDA of 5.0x.
Removing China High Speed, China Railway

Construction, and China Overseas Land
First, in September, we took some profit on China
Railway Construction by cutting our weight from 3.5%
to 1.5%. In October, the stock took a hit on the cost over-
run in its projects in Middle East. So we took out the
remaining 1.5% position.
Second, we took China High Speed out of our model

portfolio on concerns over the rising oversupply pressure
for the sector.
Third, we deleted China Overseas Land from our model

portfolio due to our concern over a possible slow-down
in its future growth.
Adding weight to insurance, IT, and service

With the proceeds, we add Lenovo (1.5%), Digital China
(1%), and Vanceinfo (1%) to our model portfolio, and
further boost our position in Ping An Insurance-A from
2% to 6%.
29
(852) 2800-8511 24 November 2010
Table 13: J.P. Morgan Model Portfolio for China

Change (%) MSCI JPM Dev. P/E (x) DY (%) ROE (%)
Ticker Price Rating 1m 12m Weight Weight (%) 2010E 2011E 2010E 2010E
Consumer Discretionary MXCN0CD INDEX 303.1 0.0 15.0 5.9 4.0 -1.9 18.4 15.7 1.6 20.1
Belle International Holdings Ltd. 1880 HK 14.4 OW 0.7 61.3 1.2 2.5 1.3 31.7 25.3 1.6 20.9
Trinity Limited 891 HK 7.8 OW -0.8 233.0 0 1.5 1.5 37.0 26.0 1.6 15.9
Consumer Staples MXCN0CS INDEX 1371.1 -3.1 18.2 6.0 14.5 8.5 21.5 17.8 1.6 17.6
China Mid-cap consumer basket JPHCHMCS INDEX 116.6 N/A -2.4 na 0 8.0 8.0 NM NM NM NM
China Yurun Food Group 1068 HK 27.9 OW -5.1 49.7 0.7 1.5 0.8 19.5 17.8 0.0 26.4
Huabao International Holdings Limited 336 HK 12.3 UW -4.8 46.6 0.4 2.0 1.6 28.7 23.8 0.0 27.3
Dah Chong Hong 1828 HK 9.1 OW -1.7 148.4 0 1.5 1.5 12.4 12.3 1.5 22.1
Hengan International Group Ltd 1044 HK 68.5 N -5.4 25.7 1.0 1.5 0.5 32.5 27.2 1.9 27.6
Energy MXCN0EN INDEX 760.3 2.3 13.7 12.8 13.0 0.2 11.7 10.5 2.9 16.3
CNOOC 883 HK 17.6 UW 10.6 40.1 0.5 6.0 5.5 14.5 14.1 2.8 26.2
Sinopec Corp - H 386 HK 7.3 OW -2.5 9.0 2.4 3.0 0.6 8.1 7.1 3.1 17.1
China Shenhua Energy 1088 HK 33.2 N -5.3 -13.3 2.3 0.5 -1.8 16.7 28.3 2.1 18.9
Yanzhou Coal Mining - H 1171 HK 22.3 N 3.2 49.1 0.9 2.0 1.1 18.4 21.6 1.4 15.9
PetroChina 857 HK 9.7 N -0.9 -2.6 4.2 1.0 -3.2 11.8 11.4 7.2 18.9
China Coal Energy 1898 HK 12.7 OW -7.8 -4.4 0.9 0.5 -0.4 13.6 NM 2.2 15.2
Financials MXCN0FN INDEX 533.5 -1.1 -2.0 40.6 39.5 -1.1 13.3 11.4 2.8 16.7
China Life Insurance 2628 HK 34.2 OW -5.1 -11.2 5.2 4.0 -1.2 24.5 20.0 0.8 15.2
Agile Property Holdings Ltd 3383 HK 11.0 OW 10.6 5.0 0.3 1.0 0.7 11.8 9.8 2.9 18.9
Ping An Insurance 'A' 601318 CH 57.7 OW -13.8 -3.2 0 6.0 6.0 173.2 143.3 0.1 21.5
ICBC - H 1398 HK 6.1 OW -0.7 -7.9 6.8 7.0 0.2 10.9 9.2 4.0 21.9
China Merchants Bank - A 600036 CH 13.6 OW -13.8 -22.3 0 2.5 2.5 10.8 8.5 0.3 19.0
China Construction Bank 939 HK 7.2 OW 0.6 4.8 6.7 2.5 -4.2 11.2 9.8 3.8 21.2
Bank of China -H 3988 HK 4.3 OW -0.1 -4.6 5.6 7.0 1.4 9.2 8.2 4.2 18.4
Bank of Communications - H 3328 HK 8.4 OW -9.4 -7.8 1.1 4.0 2.9 9.7 8.2 3.4 20.8
China Taiping Insurance 966 HK 28.3 OW -5.4 3.5 0.4 1.5 1.1 44.6 30.9 0.0 9.7
Glorious Property 845 HK 3.0 OW 11.3 -24.1 0 2.0 2.0 9.9 6.6 2.6 14.4
BBMG 2009 HK 11.7 OW 3.0 48.7 0.2 2.0 1.8 32.3 26.1 0.6 20.8
Health care MXCN0HC INDEX 162.3 -4.6 na 0.8 1.5 0.7 35.0 27.3 0.8 17.4
Sinopharm 1099 HK 29.4 UW -4.6 na 0.4 1.0 0.6 44.4 39.9 0.6 11.6
China Shineway Pharmaceutical 2877 HK 25.6 UW 6.0 124.5 0.2 0.5 0.3 24.8 24.8 1.2 25.2
Group Limited
Industrials MXCN0IN INDEX 186.2 -0.3 6.2 8.6 6.0 -2.6 14.9 13.1 2.0 12.4
China Railway Group Limited 390 HK 5.8 OW -8.6 -8.7 0.5 1.5 1.0 12.9 10.9 1.6 13.1
Geely Auto 175 HK 4.4 OW 16.2 18.7 0.3 1.5 1.2 16.6 13.7 0.8 23.3
Brilliance China 1114 HK 7.1 OW 7.6 218.8 0 1.5 1.5 30.6 22.3 0.7 18.8
International Mining Machinery 1683 HK 6.4 OW -2.4 na 0 1.5 1.5 20.7 12.9 4.8 20.5
Information Technology MXCN0IT INDEX 112.7 -2.1 13.4 5.6 8.5 2.9 28.4 20.5 0.7 17.2
ZTE Corp 763 HK 29.8 OW -6.0 -0.8 0.3 2.0 1.7 23.7 18.7 1.5 16.2
Lenovo Group 992 HK 5.5 N 6.0 28.7 0.6 1.5 0.9 49.6 27.8 1.1 3.2
Digital China 861 HK 15.7 OW 14.2 72.0 0 1.0 1.0 18.9 16.6 1.8 22.5
Vanceinfo Technology VIT US 35.8 OW 4.2 106.6 0 1.0 1.0 115.2 71.9 0.9 20.5
Baidu.com BIDU US 73.2 OW -26.8 71.2 0 3.0 3.0 50.6 33.1 0.0 52.3
Materials MXCN0MT INDEX 1095.1 -4.7 -2.2 5.9 3.0 -2.9 17.0 13.3 1.5 12.3
Zhaojin Mining 1818 HK 27.7 na 15.7 96.9 0 3.0 3.0 28.0 22.5 1.5 22.5
Telecommunication Services MXCN0TC INDEX 124.3 -5.3 2.9 12.2 7.0 -5.2 12.8 12.0 3.4 14.9
China Mobile (HK) 941 HK 78.0 N -5.2 1.8 9.6 2.0 -7.6 11.5 10.8 3.8 22.2
China Unicom 762 HK 10.6 OW -8.5 0.6 1.3 5.0 3.7 58.5 29.6 0.7 1.9
Utilities MXCN0UT INDEX 358.9 -7.0 -11.5 1.7 3.0 1.3 14.4 12.2 2.4 11.0
China Resources Power Holdings 836 HK 14.2 OW -9.7 -10.6 0.5 0.5 0.0 11.8 9.5 2.8 14.3
Shanghai Electronic 837 HK 4.3 OW 9.2 na 0 1.5 1.5 16.1 14.1 1.9 12.2
Beijing Enterprises Holdings Limited 392 HK 51.9 OW -4.7 10.1 0.5 1.0 0.5 18.9 16.6 1.6 7.7
MSCI Total MXCN INDEX 69 -1 4 100 100 0 14.4 12.4 2.4 15.7
Source: Bloomberg, J.P. Morgan estimates. Note: Updated as of November 19, 2010. * Note: The China mid-cap consumer basket was launched on July 13, 2010, so its YTD performance and
relative performance versus MSCI China only consider the share performance since July 13, 2010.
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Table 14: J.P. Morgan China Model Portfolio performance from add-in date
Weightings % Performance YTD (%) Performance from add in date Add in Add in
Ticker Benchmark JPM Ytd vs. MSCI China % Abs % vs. MSCI China % Date Price LC
Consumer Discretionary MXCN0CD INDEX 5.9 4.0 8.2 2.5 104.7 -66.4 31-Dec-04 148.1
Belle International Holdings Ltd. 1880 HK 1.2 2.5 60.2 54.5 31.9 21.9 4-May-10 10.9
Trinity Limited 891 HK 0 1.5 143.3 137.6 53.1 46.3 30-Mar-10 5.1
Consumer Staples MXCN0CS INDEX 6.0 14.5 5.4 -0.3 273.5 102.5 31-Dec-04 367.1
China Mid-cap consumer basket JPHCHMCS 0 8.0 n.a n.a 18.7 4.4 16-Jul-10 98.2
INDEX
China Yurun Food Group 1068 HK 0.7 1.5 21.1 15.4 178.5 129.3 30-Sep-08 10.0
Huabao International Holdings 336 HK 0.4 2.0 48.6 42.9 34.6 24.6 4-May-10 9.1
Limited
Dah Chong Hong 1828 HK 0 1.5 177.0 171.3 28.9 19.5 8-Sep-10 7.1
Hengan International Group Ltd 1044 HK 1.0 1.5 18.9 13.2 54.8 39.1 4-Sep-09 44.3
Energy MXCN0EN INDEX 12.8 13.0 14.7 9.0 204.9 33.8 31-Dec-04 249.4
CNOOC 883 HK 0.5 6.0 44.3 38.6 211.5 72.4 21-Sep-05 5.7
Sinopec Corp - H 386 HK 2.4 3.0 5.4 -0.3 19.5 9.6 4-May-10 6.1
China Shenhua Energy 1088 HK 2.3 0.5 -12.8 -18.5 269.7 136.6 10-Aug-05 9.0
Yanzhou Coal Mining - H 1171 HK 0.9 2.0 30.0 24.3 86.1 78.4 15-Oct-09 12.0
PetroChina 857 HK 4.2 1.0 4.1 -1.6 133.7 -37.3 31-Dec-04 4.2
China Coal Energy 1898 HK 0.9 0.5 -11.0 -16.7 -9.7 -16.5 16-Dec-09 14.0
Financials MXCN0FN INDEX 40.6 39.5 2.4 -3.3 254.7 83.6 31-Dec-04 150.4
China Life Insurance 2628 HK 5.2 4.0 -11.0 -16.7 556.7 385.7 31-Dec-04 5.2
Agile Property Holdings Ltd 3383 HK 0.3 1.0 -3.7 -9.4 26.1 16.1 4-May-10 8.7
Ping An Insurance 'A' 601318 CH 0 6.0 4.8 -0.9 12.0 7.8 27-Sep-10 51.5
ICBC - H 1398 HK 6.8 7.0 -3.4 -9.1 45.0 16.0 30-Apr-07 4.2
China Merchants Bank - A 600036 CH 0 2.5 -20.8 -26.5 5.6 1.3 27-Sep-10 12.8
China Construction Bank 939 HK 6.7 2.5 11.7 6.0 52.1 20.9 29-Dec-06 4.8
Bank of China -H 3988 HK 5.6 7.0 7.3 1.6 112.5 25.8 26-Feb-09 2.0
Bank of Communications - H 3328 HK 1.1 4.0 -1.9 -7.6 -0.2 -6.9 30-Mar-10 8.4
China Taiping Insurance 966 HK 0.4 1.5 12.7 7.0 -2.4 -9.1 30-Mar-10 29.0
Glorious Property 845 HK 0 2.0 -15.7 -21.4 39.0 32.3 15-Sep-10 2.1
BBMG 2009 HK 0.2 2.0 37.3 31.6 11.7 5.9 17-Sep-10 10.4
Health care MXCN0HC INDEX 0.8 1.5 16.5 10.8 -31.9 -203.0 31-Dec-04 238.4
Sinopharm 1099 HK 0.4 1.0 6.5 0.8 7.1 0.3 16-Dec-09 27.4
China Shineway Pharmaceutical 2877 HK 0.2 0.5 77.2 71.5 94.9 89.2 13-Jan-10 13.1
Group Limited
Industrials MXCN0IN INDEX 8.6 6.0 8.1 2.4 67.9 -103.2 31-Dec-04 110.9
China Railway Group Limited 390 HK 0.5 1.5 -4.5 -10.2 13.4 -1.7 31-May-10 5.1
Geely Auto 175 HK 0.3 1.5 2.6 -3.1 22.0 17.7 27-Sep-10 3.6
Brilliance China 1114 HK 0 1.5 224.7 219.0 89.6 80.2 8-Sep-10 3.8
International Mining Machinery 1683 HK 0 1.5 n.a n.a -5.2 -9.4 27-Sep-10 6.8
Information Technology MXCN0IT INDEX 5.6 8.5 2.6 -3.1 71.2 -99.9 31-Dec-04 65.9
ZTE Corp 763 HK 0.3 2.0 -6.9 -12.6 114.4 135.9 27-Sep-07 13.9
Lenovo Group 992 HK 0.6 1.5 13.6 7.9 0.0 0.0 19-Nov-10 5.5
Digital China 861 HK 0 1.0 51.6 45.9 0.0 0.0 19-Nov-10 15.7
Vanceinfo Technology VIT US 0 1.0 86.4 80.7 0.0 0.0 19-Nov-10 35.8
Baidu.com BIDU US 0 3.0 164.1 158.4 56.7 46.7 4-May-10 69.3
Materials MXCN0MT INDEX 5.9 3.0 -0.6 -6.3 19.4 4.3 31-May-10 917.4
Zhaojin mining 1818 HK 0 3.0 78.4 72.7 71.7 56.7 31-May-10 16.1
Telecommunication Services MXCN0TC INDEX 12.2 7.0 8.2 2.5 161.7 -9.4 31-Dec-04 47.5
China Mobile (HK) 941 HK 9.6 2.0 7.1 1.4 216.3 51.3 2-Mar-05 24.7
China Unicom 762 HK 1.3 5.0 2.7 -3.0 0.0 0.0 19-Nov-10 10.6
Utilities MXCN0UT INDEX 1.7 3.0 -7.0 -12.7 21.0 -150.1 31-Dec-04 296.7
China Resources Power Holdings 836 HK 0.5 0.5 -7.9 -13.6 -33.4 -26.3 25-Jan-08 21.4
Shanghai Electronic 837 HK 0 1.5 -1.4 -7.1 9.5 8.0 8-Oct-10 3.9
Beijing Enterprises Holdings Limited 392 HK 0.5 1.0 -7.8 -13.5 -6.8 -12.6 13-Jan-10 55.7
MSCI Total MXCN INDEX 100 100 5.7 0.0 171.1 0.0 31-Dec-04 25.3
Source: Blomberg, J.P. Morgan. Updated as of November 19, 2010. (Full details of our portfolio are available upon request; results cannot and should not be viewed as indicator of future
performance). *Note: China mid-cap consumer basket was launched on July 13, 2010, so its YTD performance and relative performance versus MSCI China only consider the share performance
since July 13, 2010.
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Table 15: J.P. Morgan China Mid-Cap Consumer (Sticky Growth) basket {Ticker: JPHCHMCS Index <GO>}
Last Price Shares Weighting MSCI China P/E (x)
Ticker Name (USD) in the Basket in the Basket (%) Weighting (%) FY10E FY11E
1361 HK Equity 361 Degrees International Ltd 0.89 27,000 5.16 n/a 14.6 11.5
SVN UN Equity 7 Days Group Holdings Ltd 22.34 700 3.35 n/a 55.9 36.1
538 HK Equity Ajisen China Holdings Ltd 1.68 7,000 2.57 n/a 33.0 25.9
1234 HK Equity China Lilang Ltd 1.42 21,000 6.29 n/a 27.3 20.9
2319 HK Equity China Mengniu Dairy Co Ltd 2.77 8,000 4.76 0.50 24.1 19.1
1068 HK Equity China Yurun Food Group Ltd 3.59 9,000 6.90 0.71 21.3 17.7
210 HK Equity Daphne International Holdings Ltd 1.13 24,000 5.73 n/a 20.6 15.9
175 HK Equity Geely Automobile Holdings Ltd 0.56 60,000 7.24 0.33 18.8 15.3
1169 HK Equity Haier Electronics Group Co Ltd 0.94 36,000 7.06 n/a 19.6 14.1
HMIN UW Equity Home Inns & Hotels Management Inc 48.20 700 7.23 n/a 31.6 28.1
336 HK Equity Huabao International Holdings Ltd 1.58 19,000 6.45 0.40 28.8 23.6
2331 HK Equity Li Ning Co Ltd 2.70 7,000 4.14 0.29 17.0 14.8
848 HK Equity Maoye International Holdings Ltd 0.47 20,000 2.03 n/a 29.7 22.6
589 HK Equity Ports Design Ltd 2.73 9,000 5.59 n/a 20.4 17.4
2010 HK Equity Ruinian International Ltd 0.77 34,000 5.63 n/a 17.1 13.1
SNDA UW Equity Shanda Interactive Entertainment Ltd 40.29 700 6.04 n/a 19.2 16.7
829 HK Equity Shenguan Holdings Group Ltd 1.32 8,000 2.28 n/a 28.0 21.2
3331 HK Equity Vinda International Holdings Ltd 1.21 24,000 6.32 n/a 21.3 16.2
8277 HK Equity Wumart Stores Inc 2.41 4,000 2.08 0.19 36.5 29.1
1368 HK Equity XTEP International Holdings 0.88 17,000 3.16 n/a 16.3 13.5
Source: Bloomberg, J. P. Morgan. Note: Updated as of 19 November 2010. Note: Bloomberg subscribers can use the ticker JPHCHMCS Index to access tracking information on JPM China Mid
Cap Consumer (Sticky Growth) basket created by the J.P. Morgan Delta One desk to leverage the theme discussed in this report. For information on JPM China Mid Cap Consumer (Sticky Growth)
basket, please contact your J.P. Morgan salesperson or the Delta One Desk.
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Companies Recommended in This Report (all prices in this report as of market close on 23 November 2010)
361 Degrees International Ltd. (1361.HK/HK$6.66/Not Covered), China Citic Bank - H Share
(0998.HK/HK$5.50/Overweight), China High Speed Transmission (0658.HK/HK$15.34/Overweight), China Lilang Ltd.
(1234.HK/HK$10.50/Not Covered), China Minsheng Banking - H (1988.HK/HK$6.95/Neutral), China Overseas Land &
Investment (0688.HK/HK$15.38/Overweight), China Railway Construction Corporation Limited
(1186.HK/HK$9.67/Overweight), Daphne International Holdings Ltd. (0210.HK/HK$8.52/Not Covered), Haier Electronics
Group Co (1169.HK/HK$7.08/Not Covered), Maoye International Holdings Ltd. (0848.HK/HK$3.68/Not Covered),
Ruinian International Ltd. (2010.HK/HK$5.76/Not Covered), Shenguan Holdings Group Ltd. (0829.HK/HK$10.18/Not
Covered), Vinda International Holdings Ltd. (3331.HK/HK$8.99/Not Covered), Zhaojin Mining Industry - H
(1818.HK/HK$27.75/Not Covered)
Analyst Certification:
The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily
responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with
respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report
accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research
analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the
research analyst(s) in this report.
Important Disclosures
• Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for China
Overseas Land & Investment, China Railway Construction Corporation Limited, Maoye International Holdings Ltd. within the past
12 months.
• Analyst Position: The following analysts (and/or their associates or household members) own a long position in the shares of China
Citic Bank - H Share: Cindy Xu.
• Client of the Firm: China Citic Bank - H Share is or was in the past 12 months a client of JPM; during the past 12 months, JPM
provided to the company non-investment banking securities-related service and non-securities-related services. China Minsheng
Banking - H is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company non-
investment banking securities-related service and non-securities-related services. China Overseas Land & Investment is or was in the
past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services. China
Railway Construction Corporation Limited is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided
to the company investment banking services. Maoye International Holdings Ltd. is or was in the past 12 months a client of JPM;
during the past 12 months, JPM provided to the company investment banking services.
• Investment Banking (past 12 months): J.P. Morgan received, in the past 12 months, compensation for investment banking services
from China Overseas Land & Investment, China Railway Construction Corporation Limited, Maoye International Holdings Ltd..
• Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking
services in the next three months from China Minsheng Banking - H, China Overseas Land & Investment, China Railway
Construction Corporation Limited, Maoye International Holdings Ltd..
• Non-Investment Banking Compensation: JPMS has received compensation in the past 12 months for products or services other
than investment banking from China Citic Bank - H Share, China Minsheng Banking - H. An affiliate of JPMS has received
compensation in the past 12 months for products or services other than investment banking from China Citic Bank - H Share, China
Minsheng Banking - H, Maoye International Holdings Ltd..
• "J.P. Morgan Securities (Asia Pacific) Ltd ("J.P. Morgan") is acting as joint bookrunner to China Overseas Land & Investments Ltd.
(“COLI”) on a proposed USD high grade bond offering. The transaction is expected to settle on 10 November 2010. J.P. Morgan will
receive a fee for so acting. J.P. Morgan or one or more of its associates may perform, or may seek to perform, other financial or
advisory services for COLI and may have other interests in or relationships with COLI, and receive fees, commissions or other
compensation in such capacities. J.P. Morgan or one or more of its associates may have received fees, commissions or other
compensation from COLI in the past 12 months, and expects to become entitled to receive such fees, commissions or other
compensation in the future, in addition to the fees referred to above. J.P. Morgan and its affiliates may also deal in, hold or act as
market maker in relation to securities issued by COLI and receive fees for doing so."
Important Disclosures for Equity Research Compendium Reports: Important disclosures, including price charts for all companies
under coverage for at least one year, are available through the search function on J.P. Morgan’s website
https://mm.jpmorgan.com/disclosures/company or by calling this U.S. toll-free number (1-800-477-0406)
Explanation of Equity Research Ratings and Analyst(s) Coverage Universe:

J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the
average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve
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(852) 2800-8511 24 November 2010
months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s)
coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of
the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] J.P. Morgan Cazenove’s UK Small/Mid-Cap dedicated research
analysts use the same rating categories; however, each stock’s expected total return is compared to the expected total return of the FTSE
All Share Index, not to those analysts’ coverage universe. A list of these analysts is available on request. The analyst or analyst’s team’s
coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying
analyst(s) coverage universe.
Coverage Universe: Frank Li: Brilliance China Automotive (1114.HK), China Coal Energy - H (1898.HK), China Shenhua
Energy (1088.HK), DongFeng Motor Co., Ltd. (0489.HK), Geely Automobile Holdings Ltd. (0175.HK), Great Wall Motor
Company Limited (2333.HK), Guangzhou Automobile Group Co. Ltd. (2238.HK), Minth Group (0425.HK), Qingling
Motors Co (1122.HK), Sinotruk (3808.HK), Weichai Power (2338.HK), Yanzhou Coal Mining - A (600188.SS), Yanzhou
Coal Mining - H (1171.HK), Zijin Mining Group Co Ltd (2899.HK)
J.P. Morgan Equity Research Ratings Distribution, as of September 30, 2010

Overweight Neutral Underweight
(buy) (hold) (sell)
J.P. Morgan Global Equity Research 46% 43% 12%
Coverage
IB clients* 49% 45% 33%
JPMS Equity Research Coverage 43% 48% 8%
IB clients* 69% 60% 50%
*Percentage of investment banking clients in each rating category.
For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold
rating category; and our Underweight rating falls into a sell rating category.
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JPM China Strategy 112410

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Asia Pacific Equity Research

• We take a short-term (1-2M) cautious view on MSCI China, which China

• We maintain our medium-term (12M) positive stance on MSCI Lan Deng

MSCI China is trading at what we believe to be an undemanding 50

of 16.0x; and (5) MSCI China’s increasing attraction on Rmb

We take a short-term Rising concerns about possible near-

2002 2003 2004 2005 2006 2007 2008 2009 2010

MSCI EM MSCI China

Source: Bloomberg. Source: CEIC, J.P. Morgan estimates.

Source: CEIC, J.P. Morgan estimates.

Consumer Disc 8.2%

Health Care 16.5%

-10.0% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0%

Source: Bloomberg. Updated as of November 19, 2010.

Source: CEIC, J. P. Morgan estimates.

That said, we believe the above monetary tightening

(a) One RRR rise will only sterilize about Rmb350

(b) On one hand, an interest rate rise can send a strong

Given that it will take a relatively long time to contain

10.0 CPI peaked out at 8.7%oy a in Feb 2008 120

Notably, food inflation on an average has contributed to -5

Table 2: Percentage contribution to headline CPI growth (%oya) by component

the chance of CPI running out of control, i.e. CPI 6000

This is because: 2000

Figure 13: Cotton settlement price in Zhenzhou Commodity

35000 1st m settlement price for corn

Notably, within the last around of the bull market from

late 2007, when the headline CPI broke 7%-level and

8.0 to 6.5% in Oct 2007. 100

0.0 CPI (LHS) MSCI China (RHS) 20

Source: CEIC, Bloomberg, and J. P. Morgan Economics.

Figure 20: H-shares’ index performance and tightening measures in 2007

Source: Bloomberg, J. P. Morgan estimates.

On the other hand, we expect the government to avoid

Notably, the consensus FY10 and FY11 earnings

Figure 26: China—Consensus earnings estimate revisions for 2000

It is difficult for the government to fully sterilize the “hot 10

money” flowing into China on the back of QE2 in the US, 0

of total investments allocated to bond assets falling from Source: CEIC.

Notably, the Chinese stock market at current

In October, despite a month-on-month increase of

3 +1 std dev = 2.8x

We are overweight on: If rising interest rates prove to be sustainable in the

Table 7: Valuation summary for Chinese insurers

(2) IT sector In the consumer sector, we believe the menswear,

(C) Luxury items

Source: ACMR. Chinese luxury market’s potential—Highlights

Source: Hurun Rich Report.

Luxury consumption taking off in China’s interior

(4) Inflation beneficiaries

Indeed, as shown in Figure 46, leading companies in

CHINA LIFE P ING A N INSURA NCE ZIJIN M INING M SCI CHINA

(5) Banks costs tends to lag that in lending yield typically,

outlook remains strong. This has very positive

Source: Company data, J.P. Morgan estimates.

We, thus, argue that inflation is less of an issue as long

As shown in Table 11, the positive earnings impact from

Interbank yield chg 25 25 25 18 25 25 25 30 30 30 30 26

100 (4) IPPs and refineries, on the possible delay of

(5) Certain industrials such as wind power equipment on

Source: CEIC, J.P. Morgan estimates.

In sharp contrast to the mature markets such as the US,

According to ACMR, the percentage of passenger