Newsletter commentary Aug 2024

The market remained challenging in August, with trading volumes hovering around 500 billion yuan. Our portfolio performed well in the first three weeks but faced significant pullbacks in the last week. 

We have come to understand that strong corporate governance and effective communication with the market play crucial roles in determining the valuation of listed companies. A public company cannot operate solely on predefined principles and focus exclusively on long-term value goals set by the management. Listening to the voices of the market and society is also crucial for sustainable development.

The second-quarter performance fell significantly short of the expectations set at the beginning of the year. Initially, the market expected that the performance in the first half of the year would show good growth due to the low base from last year. However, the overall profits of listed companies, excluding those in the oil and banking sectors, declined by nearly 10% in the second quarter. The decline in profits was most pronounced in midstream manufacturing, primarily due to weak demand and substantial supply pressures. Consumer spending has increased, but the sales data for products like Chinese liquor has not been particularly strong. Much of the growth appears to be driven by channel optimization efforts rather than genuine market demand. 

Recently, there has been a policy shift towards reducing excessive competition. Meanwhile, capital expenditures in both upstream and midstream sectors have significantly declined, indicating a trend that is expected to gradually alleviate supply pressures. In the second quarter, the dividend payout ratio experienced a significant jump, highlighting the ongoing impact of the new Nine National Policies.

In recent times, policy measures have been intensified, with accelerated bond issuance and trade-in programs providing a boost to sales in the automotive and home appliance sectors. Policy directives have clearly shifted from stimulating investment to boosting consumption and services, marking a positive beginning. We eagerly anticipate the introduction of policies aimed at boosting consumption in the long term. The current trade-in programs are effectively boosting short-term consumption. From an investment perspective, these measures can increase the current EPS. However, they may not necessarily lead to a rise in valuations as entrepreneurs and investors find it challenging to predict the sustainability of these policies. It’s uncertain whether there will be advance purchases or replacements next year. Investors are raising questions about the sustainability of the P/E ratio, viewing these gains as potentially one-time benefits. 

Day by day, we tackle each challenge one by one. If long-term policies are implemented, it won’t just result in short-term gains. It could also improve the P/E ratio. For example, if mortgage rates on existing homes are reduced by 200 billion yuan, with an average mortgage term of 20 years. Without considering the time value of money or interest rate changes, a static estimate would equate to injecting 4 trillion yuan into the economy. This would significantly alter many people’s long-term economic behavior. Furthermore, implementing long-term policies to stimulate birth rates could also be a method to improve the P/E ratio. Short-term measures to boost consumption, combined with long-term strategies to increase supply, create a perfect synergy. A policy that addresses both short-term demand deficiencies and long-term supply concerns related to population structure can elevate the P/E ratio of the entire economy, not just the benefiting industries.

As inflation weakens in the US and Europe, the balance between inflation and employment is shifting towards prioritizing job preservation. The international capital inflows driven by high US interest rates in recent years may now be rebalancing. The impact of geopolitical tensions appears to be continuously dramatic, but there are signs that the potential for actual escalation is limited. The interest rates that have been supporting high returns on US assets are beginning to decline, the AI wave has seen no significant advancements for about a year, U.S. real estate prices remain high due to limited supply, second-quarter results of many listed companies indicate signs of cautious consumer behavior in the States. 

Compared to the past, there are no visibly apparent issues in the corporate and household sectors of the U.S. economy. The issues have shifted to the government, which has the capacity to manage them over the long term. However, signs of a weakening economy on a month-over-month basis have become evident.

In our view, the Chinese Yuan FX has traded to 7.1 from 7.3 amid widespread cautious expectations. Our policies are gaining momentum, the external environment is improving, and there is a growing consensus on the necessity of these measures. Both internal and external factors are undergoing changes that are beneficial to Chinese assets.

From a market perspective, trading volume has been around 500 billion yuan for a period, which is relatively low compared to the past. However, from a mid-term perspective, the actual turnover rate relative to the market capitalization is not low. Additionally, there remain significant structural imbalances in the distribution of trading volumes across different types of stocks. 

In the short term, dividend stocks might see some volatility due to issues with profit stability or a decrease in the attractiveness of rising stock prices. This could potentially affect the flow of market funds in the near term. However, it’s unlikely to change the pricing trends we’ve seen during this period. Some smaller companies, which are of good quality and have attractive valuations, are likely to attract a portion of the market funds. 

Overall, both internal and external positive forces are building up. We continuously maintain and keep patience to explore investment opportunities.