Newsletter commentary Sep 2019

In September, electronics and computer were two outperforming sectors that drove the market upwards. However, we invested little in the two sectors. We continue to be optimistic in the A share market. Meanwhile, we reduced our position in a couple of companies which we believe are facing increasing competition pressure.

In the past month, we have met with many investors to convey our optimistic view of the market to them. China’s A share market has offered an approximate 10% annual return in the past 20 years, far exceeding that offered by other major markets. In the future, we believe China stock market will continue to be one of most rewarding markets globally, coupled with declining volatility. Such combination is likely to improve the overall user experience of investors. 

Our optimistic views are based on a couple of factors: 

1) Although macro economy is facing challenge, it is still manageable. We are confident of the effectiveness of the government’s counter cyclical policies. The policy room is still huge compared with other major economies. In his most recent interview, Mr. Gang YI, the Governor of PBOC, mentioned, “Objectively speaking, in terms of the monetary policy tools, the macro prudential policy tools, or other tools, we do have enough policy room. ... I think in this process, people are worried that economic growth is slowing down, and major economies are running out their monetary policy tools. They are close to zero interest rates, or even to negative interest rates. In this monetary policy adjustment process, I think we should make most out of the normal monetary policy, and try to extend our normal monetary policy as long as possible. It will help to keep the economic growth sustainable and improve the people’s welfare.” From policy room’s standpoint, China is in a uniquely good position and policy makers will use it in a cautious manner. It is also gratifying to see that policy makers are thinking from the long term welfare perspective.  

2) Regarding valuation and earnings, CSI300 index is trading at around 12X, SSE50 index is trading at around 10X. Shares of high quality companies have appreciated for 3 years. They are no longer cheap comparing with historical mean. But we think they are still among the most appealing stocks when considering factors including earnings, visibility and valuation. The most recent half year earning season was a good test to this hypothesis. Although overall market saw a declining earning on year over year basis, high quality companies have met or even exceeded expectations generally. Those firms also invested heavily in their operation.  In terms of valuation, we believe the market is still under performing given those companies’ stability and controlling power.    It also neglects the fact that the risk free rate in China has declined significantly as result of the break of the “guaranteed repayment system” in the wealth management products.

3) Recent regulatory policies have quickly become more investor friendly on both supply side and demand side. This change is very important to long term China based investors. Disclosure based registration system will likely broaden our Investment universe significantly. Those sectors with low volatility and high expected return such as consumption, information technology and telecom might see their weighting in the index increasing by as much as 13%, if those overseas listed names are added. We are seeing more market opening, more investment instruments, more asset classes and better investor base mix.

4) Domestic households are accelerating the asset allocation migration from housing to financial products, and from quasi guaranteed financial products to NAV based financial products. In this process, good quality stocks are major beneficiaries. In terms of the external environment including trade war, we think the market has gradually got used to it and has even positively managed it. As long as the worst case scenario is not happening, which we believe is very unlikely, the implication to market is manageable. Yesterday in Micron’s earnings call, the management was optimistic about the market demand next year. However, it felt challenging to outperform due to the shifting of Chinese customers’ orders. We believe it’s extremely difficult to decouple from each other in this time of globalization. 

We have also learned that the macro factor, which is often overly discussed by the market, is not affecting the stock market in a simplistic way. The last ten year’s bull market in the US was coupled with a mediocre GDP growth rate at 2% to 4%. Many quality consumption names in China have performed very well although the retail sales growth has slowed down from double digit growth in 2013 to 8% today. Another good example is Anhui Conch, a cement company. Its earning in the last couple years has exceeded the total earning accumulated in the past history. This was achieved despite the cement consumption in China has peaked. Macro slowdown is often coupled with less competitors, less intensity in competition. From shareholder’s perspective, this factor might be more important than the top line growth. 

As regards the recent optimism in technology stocks, overall we think many stocks have been overly priced. Investors will feel challenging to make money among the hyped up expectation. Indeed, we are witnessing some breakthrough made in some segments by a few domestic technology companies. A new round of development cycle from infrastructures to hardware to applications is starting. In addition, many internet companies have shown their strong earning power when the dividend of simple user penetration is almost close to its end. However, we insist that to get profitable investment, we need to carefully compare the price we paid to its long term value. Moreover, we want to stress that, macro policy from May to July has not loosened. In contrary, it has tightened if we closely examine the PSL and housing financing data. Since August, we have seen some changes: LPR rate is declining, special purpose bond issuance is accelerating. It takes some time to see the effect of those policies.

In summary, China stock market will be extremely attractive in a fairly long term. The market is changing in a positive way for both domestic investors and foreign ones. It has become more and more investor friendly. Comparing with other markets, China’s stock market has better growth. Comparing with its own past, it has better governance and better culture for shareholder’s return. In the past few years, US companies have done a lot share buybacks. Chinese companies have just started doing so. We strongly believe that picking good companies and investing for the long term will generate good rewards for investors.