Newsletter commentary May 2022

In May, the market generally rebounded following the oversold at the end of April. The rapid decline in April was caused by the extreme concern of the market over the epidemic in Beijing. Although not fully rational, the concern triggered some technical stop-loss orders and fueled the decline. Now the market has returned to the position slightly below where it was in late April. That market level is quite reasonable now as the Chinese economy has suffered some setbacks in the past two months. In our view, we continue to maintain active investment approach because we think that this is a one-off event. Having said that, despite the market has recovered gradually, the economy has a long way to recover.

Compared with the beginning of the year, or taken a long-term view, how do we understand the current market to determine our future investment? At the same time, how can we find out what, where and when to invest in China?

In the past few years, many countries around the world have installed monetary and fiscal policies and structural tools to support their own economies. These measures inevitably created some conflicts while hurting the global economy as a whole.  

In China, some mildly structural tools were utilized to support small and medium-sized enterprises (SMEs) and controlled the real estate industry. 

In the past two years, China has enjoyed the benefits of QE in the overseas markets, reflecting in the increase in trade share and the strengthening of the renminbi. In the third year of the epidemic, the difficulties will increase in Chinese economy due to tightening in the overseas market, as reflected in the fluctuations of exchange rate. The easing policies can boost only short-term and are unsustainable growth, otherwise there will be no concerns on the economic growth as issuing money can do the trick. 

As things have returned to normal, our economic growth potential is still relatively prominent. The question is “ how much the epidemic has affected us? No doubt, some unexpected events have exposed a few existing problems earlier than expected or more fully, also changed the priority of development. For foreign investors, China's thriving supply chain advantage was both impressive and alarming at the same time. On the China front, there is a domestic consensus that “focusing on economic construction is important and achievable”. We may see some radical measures to make up for the losses caused by the epidemic lock-down. This is important for short-term performances, restoring confidence, and protecting the faith for the future.

In a big picture, the structure of the Chinese economy may have undergone considerable changes over a short period of time. Some obvious changes include the change of proportion between manufacturing and service industries caused by overseas stimulus policies and unstable supply chains, and amplified by.

Epidemic in some parts of China this year. Another change was that the unexpected decline in the real estate sector had a greater impact on the related industrial chain than that of the expected, 1.7 billion square meters in sales decline. That was just the first step impact on related industries, and then the economic structure, and tax structure would be affected too. In general, a decline in government revenue from one part of the real estate sector needs another sectors’ revenue to make up. We are looking forward to a combination of changes in real estate related policies to support that sector as it is a vital powerhouse of the economy. 

Several of our industries have achieved huge improvements such as photovoltaics, new energy vehicles and semiconductors, in the past few years. The former two have gained a leading edge on a global scale. The difficulty in investment now is that they have all made huge profits because of short supply in the past period and the profits will return to normal in the future. The two sectors both are facing the problem of unrealistic valuation under extremely high expectations of ultimate penetration. 

In terms of investment landscape, there seems to be a lack of investment mainstreams, and it is a problem globally. The fancy bonus of Internet business is coming to an end as the policy environment is tightening globally. Falling from the peak two years ago to the bottom this year, however, it is still much better than most other industries, based on its nature of business scale advantage. 

Pharmaceutical has been disrupted from innovation to overseas markets because of the pandemic. There is always a challenge of limited funds versus unlimited medical needs that determines the flow of investments in medical care. Meanwhile, the changes of external environment have dramatically changed the costs and benefits of going overseas.

Moving into food and beverage sector, the innovation of food was vigorous in the past few years. The main driver was hot-capital chasing short-term profit and creating the booming. However, the competition pattern is not healthy. The high-end liquor sector seems hard to eliminate the tax risk in the medium and long term.

Meanwhile, carbon peaking and carbon neutrality, seems a long-term business that has passed its enlightenment stage, continuing its long journey of innovation and investment.

We may not have been fully aware of the changes in the environment. For example, inflation used to ease with a decrease in demand and an increase in supply. Now it may be that the increase in supply did not come as expected, and the weakening of demand will still occur, but the gap between the rich and the poor is a global issue to weaken demand in more complex way. The biggest story of the global economy in the past 20 years is that China has joined the global supply chain, which has brought low inflation and good growth. In the future, it will not be easy for this pattern to repeat. Investors will have to face the reality that investment returns may not be as good as before.

The market volatility will remain high, in which good assets will become more scarce, and the definition of good assets in investors' minds will also change. Recently the turmoil of cryptocurrencies roughly exampled this new round of mindset changes. Maybe there is a little bit of innovation, but we think that too much capital were chasing too little assets and then simply disappeared.

The attractiveness of stocks after the recent fall is not bad compared to other assets, even if the growth story is no longer so exciting. In the mist of ambiguity, the hidden opportunities of optimization and local innovation after major corrections are amazing. For example, semiconductors have made rapid progress in the past few years for Chinese companies. More, it is the alpha of Chinese companies themselves. Despite the individual stocks have fallen a lot, the sector is still a good investment story fundamentally. 

In the future, we will have to face trivial investment opportunities for a period of time. In the days without big fish and big meat, small fish and shrimp are also wonderful.

For investing in Chinese stocks, a cautious market view has prevailed as reflected in the ups and downs. We believe that there have been some relatively favorable changes. In the context of inflation, our bottom-line thinking in the past few years has made us less stressed than most countries. However, the short-term impact of the past two months is not small, it is easy for us to reach a consensus now that development is the solution to all problems. The rest are just technical details, and there is always a way. Been through the ups and downs, our yearning to achieve a better life through hard work has not changed much, which is the source of wealth creation.