Stocks are approaching a sweet spot, with 1) economy recovering without overheating, 2) reflation without hyperinflation, 3) monetary policies remain highly accommodative. We raise our HSI target range to 26,000-31,300, to reflect higher earnings, more visibility and less downside risk. Accumulate growth stocks in anticipation of outperformance in 2H21.
- Economy recovering without overheating. Economic data keep surprising positively in major economies since Q3 2020, while vaccination makes the recovery more visible. Earnings forecasts have been trending up. But despite the ongoing recovery, the economy is by no means overheating, with the US unemployment rate still elevated and China's GDP growth slowed down in Q1 on a 2-year CAGR basis.
- Reflation without hyperinflation. The Fed maintains that the rise in inflation is largely transitory, and the bond market seems to agree, with the breakeven rates having stabilised. In China, we expect PPI YoY growth may well exceed 5% in 2Q21 and then slow down in 2H21. We are having reflation rather than hyperinflation in the US and China. Reflation is actually positive for equities in terms of earnings and margins.
- Monetary easing intact. The Fed reiterated their aim to achieve inflation moderately above 2% for some time. Fed Chair Powell said in Apr that it was not the time to talk about tapering QE yet. We believe there will be no change in asset purchase and fed funds rate in 2021. In China, there are risks of policy tightening on the housing market, but broad-based monetary tightening or stock market-specific tightening measures are unlikely.
- HSI target range raised to 26,000-31,300, based on 10.8x-13.0x P/E of the average of 2021E and 2022E consensus earnings, because: 1) Consensus EPS for 2021E / 2022E has gone up by 2.4% / 1.3% since Dec 2020; 2) More visibility in recovery thanks to vaccination, and thus less downside risk; 3) More growth / new-economy stocks have been and will be more quickly added to the HSI, boosting earnings growth prospect and target P/E.
- Strategy: Accumulate growth stocks. We expect HK stock market’s sentiment to gradually improve after digesting higher inflations and bond yields and risks of monetary tightening. Looking into 2H21, we expect growth stock to outperform cyclicals again. Accumulate internet giants on probes-induced weakness. We are positive on technology sector too.
- Avoid upstream commodity stocks. Commodity stocks are benefiting from economic recovery and rising energy and metal prices, but we believe stock prices may have fully priced in the positives. Supply bottlenecks will be resolved sooner or later. Another risk is China might take action to cap commodity prices to curb inflation.
Key risks: 1) COVID-19 virus variants and / or rebound of new cases in major economies; 2) Inflations exceeding expectations; 3) Earlier-than-expected monetary tightening; 4) Geopolitical risks, e.g. Russia-Ukraine tension, which may lead to risk aversion and fear of oil price spike leading to high inflations.