China's A-share market continued to decline in the second quarter of 2008, with a mild rebound in April and a subsequent sell-off in May and June, triggered by the devastating earthquake in Sichuan, soaring oil prices and lingering concerns about China's inflation and domestic tightening. The CSI 300 Index was down 26 percent.

In what is becoming a familiar refrain, oil prices broke new highs to above $140 a barrel in June, triggering fresh fears of global stagflation, which in turn caused a sharp sell-off in global equity markets.

However, latest economic data continue to show China's solid, though moderating, economic growth.

1. 2008 second-quarter real GDP growth slowed to 10.1 percent from 10.6 percent in first quarter and 11.9 percent in 2007.

2. June industrial production rose 16 percent year-on-year, fixed asset investment growth was 29.5 percent year-on-year while retail sales growth remained strong at 23 percent year-on-year.

3. Exports and imports were up 18 percent year-on-year and 31 percent year-on-year, respectively, in June with a decline in the trade surplus, down 21 percent year-on-year to $21 billion.

4. Money and credit growth continued to moderate. For 2008 second quarter, new renminbi loans at 1.12 trillion yuan were equivalent to 31 percent of the central bank's full-year target, and largely in line with the quota set by the People's Bank of China.

China's inflation pressures remain a key concern, despite easing consumer price index (CPI) readings. June CPI inflation of 7.1 percent compares with a recent peak of 8.7 percent in February.

However, the June producer price index (PPI) remained high at 8.8 percent, mainly driven by higher prices of fuel, coal and steel. Meanwhile, market concerns about policy risks have increased after the recent introduction of price controls on certain products. In turn, this has reduced confidence/visibility of corporate earnings of selective industries.

Looking forward, we believe economic conditions remain challenging globally. China's equity markets will be operating against these global headwinds, and as a result, absolute share price performance may be more linked to world financial markets than domestic economies or corporate earnings.

Nonetheless, we believe China should be well positioned to deal with those issues given its strong fiscal position and limited dependence on oil/grain imports. We continue to expect easing CPI pressure in China as food prices normalize though non-food prices should continue to trend upwards, led by higher PPI. We maintain our preference of industry leaders/consolidators and the major players with strong pricing power in respective markets and/or industries.

The author is head of Investor Communications, JF Asset Management.

(HK Edition 07/25/2008 page3)