Newsletter commentary June 2024

The market was generally weak in June, with broad-based indices all falling, some with significant declines. Only the electronics industry index rose due to the capital influx of Apple’s supply chains. And some industries dropped by more than 10%.

From an industry perspective, the real estate sector not only gave back the gains brought about by the real estate policy in May, but also experienced substantial declines. Notably, the construction materials, steel, and chemical industries in the real estate chain were all heavily hit. Even though sales in some high-tier cities improved in June. Also, the coal industry has been weak this year, even with a significant increase in electricity demand. With the consumption of production in Shangxi, the outlook is bleak.

Moreover, the non-ferrous industry has been greatly affected due to the rapid rise in prices of non-ferrous metals such as copper in the beginning of this year, which suppressed demand and led to a fall in prices. This also had a substantial impact on stocks. Meanwhile, the utilities sector has seen some growth, which is rare. This is due to the presence of many stable profit-taking stocks in hydropower and nuclear power. Most consumer goods have either seen a lack of price increase despite volume, or weak volume growth. Particularly, the price system of Baijiu (Chinese liquor) has shown signs of loosening. 

Similarly, Photovoltaic (PV) companies in the power equipment sector continue to struggle in the difficult clearance process. In the non-banking sector, securities companies are experiencing revenue pressure, while insurance companies are facing an asset drought. 

Overall, we think that the market has few bright spots, except for the high-dividend strategy which continues to maintain good attractiveness under the firm expectation of low interest rates. 

We also believe that the economic slowdown after the first quarter has already been reflected in the market. This is mainly manifested in the decline in retail growth, the continued weakness in real estate, and weak government investment. In addition, this year has seen plenty of rainfall. Starting from mid-June, the middle and lower reaches of Yantze River had two weeks of heavy rainfall, which was twice as much as the same period in history. This may fuel a negative impact on the economic data of June. 

Moving to the government investment that the market has high hopes for was slow in the first 4 months, significantly lagging the progress of the past two years. From the second half of May, the issuance of government bonds accelerated, and the issuance of national debt in May and June was large. Local government special bonds will be issued intensively in the third quarter. With the acceleration of government bond issuance, government investment may improve in the third quarter. Plus, the policy effects of replacing old with new in-home appliances and automobiles and equipment updates are reflected, but it seems to be more of an increase in quantity.

Referring to the relaxation of the new round of real estate policies, house sales have improved, mainly in large cities. Second-hand houses are performing better than new ones. As the proportion of existing houses in new houses increases, the replacement of new house sales by second-hand houses will also improve.

But the real estate sales have improved for a month and a half, and the cumulative relaxation of real estate policies has shown effects, and it is possible that the sales of new houses have bottomed out in stages. This helps to reduce the tail risk of the real estate industry, but there is still a long way to go to increase real estate investment.

This helps to reduce the tail risk of the real estate industry, but there is still a long way to go to increase real estate investment. In terms of monetary policy, it is constrained by the exchange rate. In addition, the rapid decline in market interest rates is also a reality that brings pressure on asset allocation for banks and insurance companies.

From a macro-outlook, the economic growth rate is still good, but there is no heat, mainly reflected in prices. This has been going on for a long time. The market expects a large-scale stimulus to reverse it. Now it seems that this is not a policy option at present. Therefore, investment can only be made based on reality. It is now difficult to make longer-term investment assumptions, and it is hard to change the mindset of maintaining a shorter duration either.

Furthermore, the market trading structure is also undergoing rapid and profound changes. In the future, a trading volume of trillions may be a distant thing. Mainstream trading has returned to large companies with high dividends, which naturally reduces turnover. This also deepens the discomfort of the market. There are still many companies with insufficient quality and poor liquidity.

Although it is a rocky market ahead of us, with the economic growth rate slowing down and confidence being weak, the market trading structure is also being restructured, and the external environment is complex. However, we believe there are still some positive factors in the second half of the year: the real estate market is gradually stabilizing; it has been many years since the last major fiscal and tax reform, and fiscal and tax reforms may be reopened; once the pace of bond issuance catches up, government expenditure projects will improve. Under the background of high-quality development, there are not many opportunities in total, so, it is better to look for more structural opportunities.

To summarize, the current market is sluggish, and any slightly optimistic view can easily be contradicted. Bonds have risen for 3 years, while the stock market has continuously fallen for 3 years, and investors have a strong mental inertia. The Chinese economy has its strengths, but also its weaknesses.

Assuming that if most indicators do not move in one direction and give very clear instructions, investors will be greatly influenced by mental inertia. Economic data has slowed down, and a stock market correction is normal. The decline is greater than expected, the dividend index has also plummeted, there is a large outflow of funds, and northbound funds have a large net outflow. The monthly net selling amount has reached a new high since September 2023, and the financing balance continues to decrease. 

It is worth mentioning that the economy was very strong at the beginning of the year, then fell back. We believe the current economy is better than expected at the end of last year, the interest rate level is lower, the economic expectations have improved and then worsened, but there is no reason to return to the level at the end of last year or worse.

At present, we can see that low interest rates are having an effect. For example, improvements in house sales and increased corporate investment are all in industries sensitive to interest rates. Consumption is still not very good because it is not sensitive to interest rates. This might require an improvement in income expectations or inflation expectations.

When the economy is not doing well, the effect of fiscal policy is better than that of monetary policy. The increased fiscal deficit this year has not yet been converted into an increase in government investment, the reason being slow implementation. After the Politburo meeting at the end of April, the implementation has accelerated. Recently, the issuance of government bonds has sped up, and it is estimated that fiscal policy can play a significant supportive role in the economy in the third quarter.

If we look at it from another perspective, the yen has depreciated by half over the past decade, but the trade surplus has been negative for most of the years. The decline in Japan’s competitiveness is ultimately reflected in the exchange rate. This shows the complex relationship between currency value, trade balance, and national competitiveness. It is a reminder that economic indicators are interconnected and changes in one can have far-reaching effects on others.

If trade barriers are high, competition can only take place domestically, making it difficult for prices to rise. In the current complex environment, consolidating fundamentals and nurturing vitality is a natural choice under high-quality development. If there could be a good mechanism in the future to alleviate the relationship between local government’s finances and affairs, as well as incentive issues, then it is not impossible for us to make investments following this direction.

It is worth noting a recent event that the central bank’s view on long-term bonds. From 5 warnings to personal involvement, the central bank should be optimistic about the decline in long-term bond rates from the perspective of reducing the interest rate of the real economy. 

However, it chose a very firm stance. The central bank believes that the current rapid decline in long-term bond rates implies risks. Behind this should be the central bank’s belief that the Chinese economy is returning to orderly and inflation is returning to normal. Institutions that excessively buy long-term bonds have major risk hazards. It is necessary to warn from the perspective of financial stability.