Newsletter commentary July 2021

The market fluctuated downward in July, falling sharply in the last few days of the month.  

The decline was triggered by panic due to major policy changes of sectors such as Education, which brought material adjustments to the environment within the sector and caused significant stock price drop in other sectors such as Internet and Baijiu. Meanwhile, funds continued to flow into the sectors supported by current policies such as Photovoltaics, New Energy and Chips.   

In this regard, we don’t think it necessary to worry too much about the changes in China’s policies or even doubt the prospects of the market economy. What we need is to understand the mindset behind the policies for a clearer view. China is a socialist market economy, of which the socialism solves the problem of common prosperity, and the market economy brings efficiency. The dilemma here is that travel alone is fast yet not far, while travel together is far but hardly fast. It is a big challenge to pursue the common goals of traveling both far and fast.  Knowing the challenge and greatness of achieving both goals, we are still determined. That’s why we see the shifts of focus from time to time, confusing the investors in short terms. However, aiming for multiple goals is our model and we want a development for everybody. This is like for a student pursuing the development in morality, intelligence, physical, art and labor. Therefore, having PE class yesterday, Math class today and Art class tomorrow doesn’t mean changing mind constantly but shows the goal of a comprehensive development that benefits in the long run. The market economy shall be adhered to as its advantage in efficiency has been proven repeatedly. In addition, with the development of the capital market and the network society, the feedback of information will become faster, and the communication and coordination on policies will be better.

The market goes to extremes easily. Playing something to the extreme creates hidden troubles of volatility – when going up, it goes to the top; when going down, it goes to the bottom. This is definitely exaggerated. As we said last month that the structural contradiction in valuation was the major problem of the market, previously the valuation of some stocks increased to the historical high, which is fragile as the performance is destined to be below expectations. This is because few names have been able to maintain a 20%+ growth for ten or twenty years, which was the expected growth rate that matches the high valuation of these stocks. The implied return will be low and the fluctuation will be large when the results miss.

We must be vigilant in the popular stocks recently emerged in the market, beware of the similar cases as the previous names with excessive increases. Many industries with high expectation and valuation are actually technological manufacturing, only that they include more technologies at the beginning stage than original manufacturing industries. But the history of “Made in China” suggests that many of them are eventually of the manufacturing nature where the law of supply and demand applies. Scarcely a segment can be in short supply in the long term. Only the manufacturing barriers brought about by continuous innovation will last. Investing on slogans may create structural contradiction in stock valuation. 

This contradiction can be alleviated through adjustments. The market will return to the focus of economic development and corporate profitability. Chinese economy has been the first to be affected by the pandemic and the first to be out of the influence. But the future development of the pandemic situation is still unclear due to the new challenges from the variants of the virus. A full recovery of the economy is still difficult, especially the service industries with a large number of employees will improve in a slow pace. This will build up hurdles to the growth of disposable income and to the amelioration of consumption. The contribution from exports will become weak and the sales of property is expected to decline under the firm policy of “houses for living in, not for speculation”. The tone of the policy has shifted to maintaining an appropriate growth while stabilizing the policy itself on cross-cycle goals. Under reasonable expectation, there are still many opportunities in the market, although they are more scattered than before.