China Equity Strategy:Industrial profits surged further,earnings upgrades may follow

　　Following surprisingly strong industrial profits in the prior month (see Industrial profits accelerated in Jan-Feb, so may 1Q16 earnings, 28 Mar), growth surged further to 11.1% in Mar (Figure 1), a 6.3ppt acceleration from the 4.8% in Jan- Feb, sending 3M16 growth to 7.4% (Figure 2), the highest read in 20 months. Revenue growth also accelerated to 4.8% in Mar and the cumulative 3M16 growth picked up to 2.4%, the strongest read since Feb 2015. Sector wise, mid- to downstream sectors, including petroleum, electronics, chemicals, auto and pharmaceuticals made the largest contribution to the growth surge in Mar (Figure 3), while upstream remained a key drag, though on a smaller scale.

　　Industrial inventory growth edged down to 0% in Mar, this is the lowest level since Nov 2009 and marking the 19th consecutive month of destocking since Aug 2014 (Figure 4). We believe this round of industrial destocking might have come to an end and a new restocking cycle might have started in Apr on the back of more visible demand pick-up, e.g. credit creation strengthened further in Mar and boosted infrastructure and property project new starts (see Macro data beats across the board, upgrades should follow, 15 April). We believe the combination of rising demand and low inventory suggest stronger industrial production and further price hikes in major industrial products, which support further industrial profit growth pick-up over the coming months, thanks to both improving top-line sales and expanding profit margins.

　　We have been monitoring the industrial profits data series because it is closely correlated with A- and H-share non-financial earnings growth (Figure 5), which report only quarterly. The significant industrial profits acceleration in 1Q16 (7.4% vs. -3.6% in 4Q15 and -2.3% in 2015) suggests that 1Q16 non-financial earnings growth may also improve.