Newsletter commentary Mar 2020

In the February newsletter, we discussed the risks of overseas epidemics, but we still underestimated the speed of its development.  The turbulence of the financial markets was also above our expectations. Based on our understanding of the developing process of the epidemic in China, we realized that the overseas societies had to be locked down at a starting point with a higher number of infected people. At the same time, it was difficult to achieve the magnitude of lockdown such as what China did. The strategic opportunity of controlling the epidemic by “flattening the curve”, which had been envisaged in the previous period, has been lost. Very differently, China’s approach was fast and strict. Thus the capacity utilization rate dropped rapidly, but the epidemic situation improved quickly, and then production resumed.  In contrary, overseas economies may see the decline in capacity utilization rate not as dramatic as China’s, but the duration could be greatly longer than originally envisaged. Therefore, this will have a real impact on global aggregate demand and the supply.  

We have made two adjustments in our investment. One was to re-concentrate our investment to the best assets in China. And the other was hedging against some outbreak areas, based on the different stages of epidemic development in various regions. At present, our asset allocation mainly reflects three changes. The first is the trends of business shifting online.  The second is focusing on Chinese domestic demand names. And the third is emphasizing on company quality. Our portfolio mainly invests in China's Internet services and supporting facilities, consumption and services that stood the test in the epidemic, medical equipment and products, high quality banks, utilities and manufacturing companies that are undergoing obvious upward cycles.  

The epidemic and the oil shock have brought chaos to the financial markets. Central banks of various countries can quickly restore order with the help of various tools that have been used in 2008. However, the impact of the epidemic on the economy is unknown. Even when the number of confirmed patients will start to decline in the future, it will take a long time to fully restore the normal economic life. The main risks come from the risk control of underdeveloped countries and the concealed asymptomatic infection. In addition, whether the epidemic is controlled within one month or several months matters a lot. Because potentially there will be secondary disasters. (such as unemployment, chaos in the economic order, disappearance of demand in some industries, etc.)  It is as if one can recover rather soon if suffers only one second of shock.  But for a few seconds, it may require full rescue. If for longer than 10 seconds one might not be able to recover fully.   

Now looking at various policies,  governments are trying to maintain order as much as possible so that the production capacity of the entire society is affected as little as possible, waiting for the victory of science, vaccines and drugs. 

Based on our tracking of latest drug and vaccine development, we think that in the end winning the War against the virus should be a high probability thing, but now we have to go through this difficult time. What we are doing now is to let ourselves and customers have room for patience and rational decision-making to stay in this market and wait for the coming of dawn. 

Our best guess is that post this epidemic, which is like a storm, the strong ones will still stay there and even have a better competitive landscape. Chinese assets may become a safe haven because of its unique operating model and different stages of development. . The risk is that the epidemic is endless, and capacity utilization and demand worldwide are getting harder to the pre-epidemic level.