Newsletter commentary Feb 2020

The market fluctuated in February. After two months of fluctuations, our NAV basically has returned to the beginning level of the year. 

The market after Spring Festival has the following characteristics: 

1) Thanks to strong quarantine measures, when the market reopened, it was already clear that the number of newly diagnosed patients in China was about to reach a turning point, so the market rebounded quickly after a short-term decline.

2) Benefits by the outstanding performance of technology funds last year, a large amount of money continued to flow into related funds, many of which were passive products. The sector continued to soar. Many indicators have reached record highs, and valuations have also reached historical levels. 

3) During the second half of last month, the epidemic situation in China moved into the next stage in which both prevention and control measures, and work resumption became the focus. Opportunities related to work resumption were sought after by the market, and the market began to look forward to returning to the normal mode. However, in the late-February, people’s eyes were shifted from work resumption to the global epidemic situation.  The focus has shifted from supply to demand. As other countries have difficulties implementing strong Chinese-style prevention and control measures, the trend of the epidemic has become unpredictable which has increased investment uncertainty causing volatility in the global markets.

We maintained an active investment approach. At the beginning of the month, we were confident in the prevention and control of the epidemic in China. We believed that if China would resume work in March quickly, the economic goals for the whole year would still have a chance to be accomplished. The impact in the first quarter could be made up through consumption stimulus and other policies. But at the end of February, this assumption added uncertainty coming from the global economic environment. Unlike China, other countries have not adopted “early detection and early isolation” measures which may have a short-term impact on the economy but are effective.  It is clear that the new virus is highly contagious and concealed, with not low fatal rate, which will make the epidemic to have a long-term effect. The quick combat that we originally assumed will likely become a protracted battle. If it is a protracted battle, it will increase the uncertainty of the income expectation of household as well as cash flow expectation of companies.  Thus, there is great uncertainty about the global total demand, and it will bring risks to parts of the world economy. 

Therefore, we made adjustments to the portfolio to reduce our exposure on stocks which might see longer time and more uncertainty to recover. We focused on companies that can thrive after the epidemic with higher and faster market concentration; such as online + for related companies; and companies with excellent management and better adaptability than peers and more predictable outlook and obvious progress under the same macro assumptions. We still maintain a positive investment mentality, mainly investing in internet services, electronics hardware, banking, education, health care and consumption, with some hedging in place at the portfolio level.

If looking at the situation in the long-term, the epidemic will always pass, and good companies after the epidemic will be stronger. After the double impact in 2018 and early 2020, good quality companies will be even stronger. The Chinese economy will also pass the double shocks and will make up for shortcomings. At the per capital GDP of 10,000 US dollars level, it will help us move forward better. From market perspective, the epidemic prevention and control measures in various countries will provide a good stress test across nations.  China’s country risk may further decline, and the Chinese economy may take the lead to come out of the epidemic.

Looking around the world, the yield on U.S. Treasury bonds hit an all-time low. The spread between U.S. stock dividends and treasury yield is in a very favorable position. China ’s CSI 300 is traded at about 12 times PE. (We believe that for these companies, the outbreak is more of a one-time shock), our bond yields also returned to the 2016 lows, and the long-term attractiveness of the stock is still very strong.

It will be relatively bumpy for some time in the future, but it seems that the results are relatively certain, and governments of various countries will also take a lot of mitigating measures, so we believe it is worthwhile to stick to the fundamentals of our investment strategy.