Newsletter commentary Oct 2021

In October, though market volatility seemed low in general, the internal differentiation was dramatic. New energy and electric vehicle industry chain went up, while sectors benefited from rising product prices earlier fell sharply.

The commodity market soared and plummeted. The price of thermal coal futures was once close to RMB2,000/ton and soon fell back to below RMB1,000/ton. Coal is the basic energy source of our economy. The fluctuation of basic energy prices brought confusion to the expectations and affected decision-making. China consumes 5 billion tons of coal every year, so every 100 yuan increase in price means 500 billion yuan more in total cost, a big swing in the context of China’s GDP of 100 trillion yuan or the total profitability of 4 trillion yuan of all the listed companies. From the 3Q results we see that the profit distribution among upper-, mid- and down-stream had tremendous changes. The profit of mid- and down-stream companies didn’t benefit from revenue growth due to increase of energy prices, raw material prices and freight costs, as well as curtailment, which is not sustainable.

Energy becomes the focus of the problem that is related to the following factors. First, due to bleak prospects or financing difficulties (ESG, unattractive return, etc.), the investment in traditional energy was insufficient in the past few years. Second, new energy is unstable though is growing rapidly. The price will not be low considering the quality of the energy and the consumption of a large amount of traditional energy in the early stage. Third, the pandemic has brought about an abrupt adjustment of economic structure in short-term. The proportion of manufacturing has increased with intensified energy consumption. Fourth, carbon reduction has become a consensus. In the future process of switching from traditional to new energy, we need to guarantee people’s well-being, to maintain an orderly rise in industrial and commercial power consumption, to moderate the impact on the economy, and to increase the proportion of new energy to complete the long-term energy transition. This is very hard to achieve.

At the same time, our economy is facing the switch of the track of property development, the rapid change of demographic structure, the increase of electrification, the global supply of China manufacturing that is hard to change, the room and expectation to improve the per capita income of households. All these have a great impact on our prediction of medium and long-term energy demand and of the path of carbon reduction. This judgement is important, but unfortunately, we do not have a clear idea for the moment.

An abundance of capital needs to be invested in the financial market during the transition period of the housing sector.  Meanwhile the internal structure of China economy is rapidly and significantly adjusting. The extreme differentiation in the capital market fully reflects the scarcity of growth opportunities and the worries about traditional industries, overlapped with and amplified by the large amount of capital anxiously looking everywhere for opportunities. It’s common to see the extrapolation of short-term booming. Most of the hottest sectors and names at the end of last year were no more the case, partly because of the changes in prosperity expectations, but more because the stocks were overpriced. It would be complicated to reach consensus on the prospects of an industry, then pick the good companies from the industry, and analyze price and future competition. Living in the moment, investing in the ready-made boom, and leaving tomorrow’s problems to tomorrow might be the best choice. The rise and fall of coal futures is the epitome of most industries and companies. Picking a long-term profitable company is always posteriori. Picking and always picking the current boom is a viable investment practice because long-lasting profitable names are scarce in reality.

There were not any large cap companies in China manufacturing industry before, but now it is changing. This has something to do with the transformation of the energy industry into manufacturing by Made in China national strategy, and with the global competitiveness of China manufacturing industry. The comparative advantages are different when facing a huge market. However, it is unclear whether the Chinese companies have stopped involution. The limitation of energy consumption is an opportunity, but it may also result in the reduction of competitors.

We used to discuss fiscal and monetary policies when encountered economic problems. It seems that we need new angles because huge impacts have been coming from new constraints and new environments. In the short run, we need to restore the order of the economy. The violent fluctuations of the prices of production factors are expected to be eased, but the road would be tortuous. The pandemic won’t be curbed easily, and the exit of stimulus policy is as difficult as weaning. From a long-term perspective, we are developing a new economic order. We are not allowed to make easy money or to be passive. Only openness and striving to innovate are the right way for both individual companies and the country. How to adapt to this new order is a major issue in investment.