Newsletter commentary Aug 2021

The market was split in August. The CSI 300 Index was nearly flat, the ChiNext dropped by 6.6%, whereas CSI 500 and CSI 1000 rose by 6-7%. Sectors such as non-ferrous metal, iron and steel, coal and chemicals surged by approximately 20% in August; while chips, pharmaceutical and food & beverage fell sharply. The market turnover was continuously above one trillion RMB. 

The market is still puzzled by policies, or more precisely, the interpretation of the policies by media. Although authoritative interpretations were made officially, misunderstandings were still an impediment for many. Under the market principles, the primary distribution is based on the contribution from different productive factors, which highlights efficiency. The secondary distribution instead focuses on equity. In many cases we neglect the inheritance tax, property tax or capital gains tax imposed in welfare societies that we always envy. The third distribution is encouraged to further improve equity. Although China has shifted from a high-speed economic growth to a medium-speed one with a changing demographic structure, the goal of common prosperity has never changed. In the past, China wanted everyone to develop at the same pace and it didn’t turn out to work well. Then the game changed and allowed part of the population to become rich first and to lead the rest to achieve the goal – these people are now rich and the country is aiming at the second part of the task that is achieving common prosperity. Consequently, the tax structure is going to switch from a flow-based system to a both flow- and stock-based system. Currently we are proposing to raise the baseline of basic living support while continue to boost the enthusiasm towards a better living, which is necessary for high-quality development, common prosperity, as well as internal circulation. If the gap between the haves and have-nots becomes too wide, the internal circulation will fail; if we don’t encourage continuous creation but instead promote absolute equity, the internal circulation will fail either. There is a possibility in the market that people think some of the companies will no longer seek development, which is not true. It may not be the intention of the policies if no one wants to make the cake bigger.

Most of the out-performing sectors this year have featured short supply issues. Many of them have encountered restrictions from energy supply, environmental protection, long lead-time of new supplies or other factors. This is our challenge in the pursuit of high-quality development and carbon neutrality, which requires a better overall planning. An example is under carbon neutrality, we need to develop new energy with much higher energy output than input throughout the life cycle, although the materials for the new energy are of high energy consumption themselves. Currently, the development of new energy is limited by lack of raw materials, worsened by the initiative to reduce energy consumption in all the provinces. Such initiative may have overlooked the regional mismatch between production and consumption. Experiences are, unlike resource-intensive industries, general manufacturing is hard to maintain a short supply in the long run. It may be slightly different this time, but possibly like the photovoltaic glass case, there would be a solution.

Most of the under-performing sectors this year also share a common feature – the valuation has been too high from previous stock price surge to be supported by expected growth rate or to withstand turbulences. The companies enjoying sharp rise in stock price this year should have foreshadowed a decline in the future. From a long-term perspective, it is unreliable to make long-term estimates based on the volume and price under abnormal conditions. In those circumstances the market is likely trading sentiment, not value.

One of the hurdles that the market needs to cross later is the change in the real estate industry. After more than 20 years of property market boom, it is hard to say whether the internal transaction structure is prepared to farewell the sector’s most glorious time. There have been adverse effects from epidemic on the recovery of service industry, supply chain, and disposable income in the short run. On top of that, the market did not show a sustained wealth effect in recent period. The speed of savings entering the market showed signs of slowing down as well.

The market is active with many innovations thanks to the construction of the multi-layer capital market. The promotion of both efficiency and equity may reduce the number of towering trees but will lead to a more prosperous and active ecology. And this is where the opportunities are.