Newsletter commentary Apr 2020

In April, the market rebounded significantly in the context of China ’s resumption of work and the gradual control of overseas epidemics. The rebound in overseas markets has basically been rehearsed in the Chinese market in which online economy gets more opportunities, domestic demand is preferred, and industry leaders are less affected.

With regard to the epidemic, compared with more than a month ago, and based on our understanding of the virus, we are more confident that the long-term impact of the epidemic on the economy will be limited: Human capitals that affect the long-term potential of the economy are not significantly affected. There will be a slight impact on future capital investment, because the balance sheets have deteriorated after a few months of the global economic shock.  progress of science and technology has not seen major impact, and may also accelerate in the field of healthcare. Post the epidemic, the greater impact may be the atmosphere of global cooperation, which may have some adverse effects on the optimal allocation of resources by market players globally. Although rational analysis and cooperation is beneficial to overall welfare, but when everyone is frustrated, structural problems will overwhelm. Anger and finger pointing will dominate reasoning. Cooperation does not have to happen, especially during the election year. This kind of sentiment is easy to be manipulated, amplifying the risk. A certain degree of De-globalization will occur. This is a background that the future investment needs to face for a long time.

For short and medium term impacts, we believe that various economies will have a V-shaped rebound during the restart process after the outbreak is controlled, but it may take longer to fully restore to the original state.  Similarly it will likely be fast to take capacity utilization rate from 50% to 80-90% level, but it will be slower to return to 100%. With the strong fiscal and monetary policy support of various governments, the secondary disasters caused by the epidemic have been controlled within a relatively small range. This kind of life-saving and rescue policy has protected the productive capacity of the whole society to the greatest extent, and has not brought other chaos. Economic shocks will gradually subside. A period of recession is inevitable, but the continued depression can be ruled out. Compared with the long period of difficulties in history, the difference this time is still very obvious. First, the people ’s confidence has not been greatly damaged after a long period of impact. The Chinese experience shows that the duration in which economic life is greatly affected is about one quarter. Secondly, the central banks of various governments have taken rapid and powerful measures to help people and enterprises overcome the difficulties. From the perspective of the magnitude and speed of the expansion of central banks ’ balance sheets, compared with any crisis in history, it has been more decisive and effective. Thirdly, such policy measures have blocked continuous and secondary disasters. Unlike previously, banks are not in bad situation, which greatly reduced the risk of interruption of transmission mechanism from central bank to banks to private sector. As a result, social conflicts have not rapidly intensified. Therefore, this time the recession is due to the economic shock caused by the public health crisis. As the epidemic eases, the risk of long term low output is not great. It is more likely that the balance sheets of central banks, enterprises and household would deteriorate. Therefore, the repairs required will affect the potential of the future economy.

The focus of the market now is whether we can skip 2020 and instead directly look at 2021, as if there has not been an epidemic. Looking at the Q1 earnings, almost all companies have been greatly affected by the epidemic. Very small amount of companies benefit from the epidemic. Some of the benefits are short-term, but some are long-term. For example, education companies have quickly completed the online class migration with very little promotion costs. Almost all the companies and brands have to adopt some online strategies. Some companies may withdraw permanently from the market, giving the remaining companies more room for development. The market has been more generous to companies with short term certainty, and has also given some premium to companies with long-term certainty. Some companies have reached new highs. Looking at the recovery timeline of many domestic industries, we found that after the recovery of demand in March, the follow-up recovery showed signs of slowing down. The market may eventually realize that it is not easy to return to year-on-year growth. Other countries will likely also experience this process in the future. From the perspective of China, conditions for further full-scale resumption of work have been met. However the bottleneck for the subsequent resumption of work is demand, especially external demand and supply chain risks. This needs overseas work resumption to reach a better level. This seems at least to be a gradual process from the second quarter. The market has clearly made some good expectations for this, leaving little room for error. In our opinion, the long-term outlook are relatively certain, and short-term volatility is also normal. Low valuation, competitive advantage, long-term demand, and global investors' demand for additional allocation of Chinese stocks still work for Chinese equity market. 

The resumption of overseas economic activities will start gradually in May, and the demand for China’s goods may lag for a while. The consumption and service sectors of major overseas economies have relatively higher weight. Under the influence of social distancing, the resumption of their economies may be more gradual than that of Chinese industrial sector. Therefore although the gradual improvement in the next few quarters is certain, the slope may not be too steep. One possible surprise may come from the active initiatives of domestic policies. But from recent policy statements from six stable to six guarantees, excessively high expectations of stimulus policies are unrealistic. It seems the chance is increasing for China to preserve the strength and wait out the situation. The risk comes from the recurrence of the epidemic, but it should be a controllable one.

Judging from the most recent financial reports of domestic companies, we have seen the continued differentiation of various industries. The optimization of the industry structure will be more likely to occur in difficult times, such as the express delivery industry. The capital expenditure / depreciation of many manufacturing companies has continued to decline, and their balance sheets have continued to improve.  Some have seen the net cash position. The conditions for better dividends have gradually improved. What’s more, the investment led model of China ’s economy has gradually been validated by listed companies. Some electronic companies that have rarely experienced continuous positive cash flow in the past have seen continuous improvement, gaining share in the global supply chain. There are also many service companies that have significantly increased the proportion of overseas revenue, such as game entertainment and some service outsourcing companies. Many listed companies continue to maintain high research and development expenses, which will be very helpful to build continuous barriers to competition. In extraordinary times, it is also a time to test the company's management ability. In the process of resuming work and expanding online sales capabilities, many companies have demonstrated the advantages in technology investment and ability to adapt promptly. There are many examples in the fields of banking, sports apparel, and home appliances. It is a difficult time overall, but we still see many hopes and highlights. In addition, there is a common revelation in the Chinese and American stock markets. The Nasdaq has recovered far faster than Dow Jones. The Chinese market is similar. Those high tech companies that continue to invest heavily have been sturdier and recovered faster than other companies. Technology is an important differentiating factor.

To sum it up, we may have passed the most difficult time, but it will not be easy going forward.  Still, there are many investment opportunities with a longer perspective. The future winners may be the beneficiaries of the online trend, the remaining winners, and the enterprises and entrepreneurs with continuous high investment into the future. We are prepared to focus on those companies with a positive attitude.