Newsletter commentary Nov 2023

In November, the CSI 300 Index dropped by over 2%, while the CSI 500 Index remained relatively stable, with the CSI 1000 Index posted a rise of around 1%, and the CSI 2000 Index increased by over 2%. The Beijing Stock Exchange 50 Index (BSE50) ended a sudden surge of approx. 50%. Plus, high-frequency economic data did not provide a clear sentiment of direction. We believe that the divergence in the performance of these indices are likely more related to changing of investor’s structures.

During the past months, the US economy has essentially reached the peak, with inflation cooling down and interest rate hikes plateauing, as expansionary fiscal policies and excess savings have made significant contributions to the economy this year. Ultimately, looking forward these driving forces are most likely to face challenges.

In China, compared with the beginning of the year, the Chinese economy has seen better-than-expected export performance, which has not been a drag on economic growth. But the real estate sector has been weaker than expected and continues to weigh on the economy, although the extent of the drag has significantly decreased compared to last year. Infrastructure investment has played a stabilizing role, albeit on a high base. Consumption remains the main driver of economic growth, but its recovery has been gradual rather than a retaliatory rebound. There are also clear signs that consumers are placing more emphasis on value for money. This may be unfavourable for investors who prioritize profit and profit margins.

From the perspective of this year's prices, relative to our production capacity, there is insufficient demand, and the economic potential has not been fully tapped. There are reasons for significant structural adjustments, such as the sharp contraction of the real estate chain for two consecutive years, with some sectors experiencing a 50% reduction. This has put significant pressure on all participants in the industrial chain. Recently, the financial regulatory authorities have introduced measures requiring banks to ensure that their own real estate growth rates are not lower than the industry average, that non-state-owned real estate enterprises' corporate loans do not grow slower than the bank's real estate growth rate, and that personal mortgage loans for non-state-owned real estate enterprises do not grow slower than the bank's mortgage growth rate.

The policy guidelines suggest a shift from restrictive to supportive financial policies related to the real estate sector. In terms of stimulus policies, direct cash transfers to stimulate consumption are not the primary choice. In the future, it is likely that income will be increased through expanding infrastructure investment, which will then drive consumption. From this perspective, there may not be an explosive turning point. According to consumption, the previous approach of upgrading consumption, especially in areas where value creation is limited, will continue to be suppressed. In particular, the price increases as a business logic will face sustained pressure in the future.

Consumption can be seen as the beacon of hope for the current Chinese economy, as evident from various consumption indicators. However, the transition to sustained actual consumption also relies on the continuous improvement of income expectations, particularly for those with lower incomes categories. Another method that can have an immediate impact on increasing the consumption rate is to increase expenditures on equalizing public services while reducing the portion of government spending related to construction.

Nevertheless, considering the decrease in local government revenue from land sales, the actual net income available for discretionary government spending is not significantly impacted. This shortfall can be offset through proactive fiscal policies. Apparently, the process of land consolidation undertaken by the government also contributes to GDP growth. Overall, increasing public service expenditures should be able to bring an improvement in the consumption rate relatively quickly.

From another aspect of boosting consumption is increasing effective supply. Referring to two examples, such as Guizhou Village football and Zibo BBQ events, are highly enlightening. We look forward to the emergence of more similar supply to accelerate the arrival of the stage of service-oriented consumption.

Furthermore, another hope comes from technological and industrial breakthroughs, which is an ongoing process. There may be some landmark progress in the coming year, equivalently the opportunities brought by new energy in previous years.

At present, the A-share market has largely deleveraged the debt from the 2019-2020 blue-chip stock bubble, and overall valuations have become more reasonable. However, structural contradictions still persists. For example, institutional investors' holding structure, and historical lows lack momentum. The valuations of some small-cap companies are still historically high, and the recovery of future cycles after supply-demand reversals in certain industries may be prolonged.

Looking ahead compared to the expectations at the beginning of 2023 and the subsequent developments, it is probable that the China-US interest rate differential will transition from widening to narrowing. The profitability of listed companies experienced negative growth this year but is expected to recover and grow in the coming year. Furthermore, although China's 10-year government bond yields has decreased this year, A-share investors currently have a greater perspective on risk-reward ratios from a global investment standpoint.

In our view, the pressure that some investors feel, tethered to US bond yields, is likely to ease after the interest rate differential narrows. There may not be dramatic changes or sudden shifts, so it may be prudent to focus on finding suitable companies for investment rather than being swayed by short-term market fluctuations.