Newsletter commentary Jun 2020

In June, A-shares and Chinese assets remained strong.  Overseas markets were more volatile due to impact from central bank’s actions, announcements, and epidemic situations.

Half the year has passed, during which an epidemic has occurred. The daily life and work have been greatly affected and far from recovered. However, many asset prices have returned to the historical highs. What have we learned, or which are beyond imagination?

One is the role of visible hands, including the role of the central bank, the Ministry of Finance, and various other supports. Especially in the short-term, the effect can be overwhelming, even for such a large epidemic. The US household income grew by a rare 10%+ in April growth sequentially, which refreshed our understanding. Therefore, the market’s expected epidemic impact on the economy was almost completely different from that in history. The secondary impact was basically cut off. Everyone took the strategy of "Keep the green hills and win the future". This looks like a policy upgrade of the paper money society after the Great Depression and the 2008 crisis, and now it seems to be a success.

The second is that under the current policy transmission mechanism, the market signal required to restore production confidence is the rise in prices. It seems that both fiscal and monetary stimulus need to boost asset prices to restore confidence and production, and then wage income. Therefore, people with assets will benefit first, which seems to be set by the system. The long-term result is that the gap between rich and poor will widen further.

Thirdly, the effectiveness of diversification has been greatly challenged. US stocks and Chinese assets have significantly outperformed others. Nasdaq continues to outperform Dow Jones after many years, and digital companies are particularly dominating others. The divergence within the same industry also continues.

Fourthly, Chinese assets continue to be favored by overseas investors. The attractiveness of Chinese equity in the Chinese domestic asset allocation has greatly increased with the decline in the relative attractiveness of almost all other asset classes. More and more investors realize that for long-term double-digit returns, China’s equity is a good choice.

The continuous rise of A shares is not the evenly spread. Now the internal valuation difference has reached a very high level. We had some expectations for this, but there are still some surprises. Our tentative explanation is: the decline of expected return is absorbed by a few companies that are considered to have long-term growth potential; an increasingly transparent world has accelerated the differentiation of operations within various industries; with the weakening of the economic cycle and the difficulty of clearing out the excess capacity, the traditional mean reversion opportunities are becoming more and more difficult. However, under the same conditions, the current high-valued stocks must indicate a decline in future returns.

We still feel confident towards the future. Recently, the universe of China’s equity assets has increased rapidly. More and more ADRs are returning to Hong Kong. More and more entrepreneurial companies are listed, which expands our investment options. Overall valuation is reasonable. What is more, the decline in the attractiveness of other asset classes should be structural, and the increase in demand for stocks should also be structural. Although the epidemic situation could come up again, but under normalized prevention and control, production and epidemic prevention can achieve possible balance. We will wait until the advent of vaccines or drugs.

After this epidemic, the online migration of the entire economy and society has been accelerated. We are optimistic about the “water, electricity and gas” in the online era. These infrastructure providers are well positioned in the future. They include cloud services, brands and services with pricing power, and some emerging industries at the critical growth point.

The Chinese economy may be one of the few large economies with further policy easing space. The market may underestimate the gradual normalization of those temporary stimulus policies, which might undergo some short-term volatilities. 

Before the outbreak, Modern Monetary Theory (MMT) was just a theory, now it has become a common practice. We do not know the future implications. We have already enjoyed the short-term benefits, such as preventing the depression caused by the downward spiral effect. In the future, there are indeed some things that are not the same as before, but the best strategy now is to invest in quality stocks, in our opinion.