Newsletter commentary May 2020

In May, the focus of the domestic market shifted from the epidemic situation to Sino-US relations. Overseas markets continued to respond to improving epidemic situation with resuming production. During the month, we temporarily hedged against a rising conflict risk but overall maintained an active investment approach. For the epidemic, we believe, for a long period of time, some control measures will stay in place and become the new normal. But the risk of second wave bringing great impact has declined. Meanwhile, many new lifestyles may have been formed and maintained. The inter-city traffic is recovering more slowly than that of the inner-city. Many online activities may have accomplished their goals many years in advance, such as the increase in the supply of high-quality local services, and the faster speed of e-commerce penetration to lower tier cities. 

Looking at the performance of many companies in the first quarter, we noticed that now data and information have become the new economic infrastructure, just like electricity and gas were previously. In the epidemic, these companies were almost unaffected, even beneficiaries. It seems that for ordinary people, in addition to death and taxation, one can hardly live without these new infrastructures, plus the price is not regulated.

From market perspective, as unexpectedly as the rapid decline brought by the epidemic, the speed and magnitude of the rebound are also beyond expectations. In terms of the rebound speed before and after the epidemic, the difference between countries is not small, the difference between industries is not small, and the difference between companies within the same industry is also not small. Although the economic life has not recovered, it is flooded with new liquidity, which is beneficial to asset prices. Still, the differentiation among asset returns is very interesting. One reason may be that the growth rate of many industries has declined, or even declined faster, than the decline of the cost of capital. So most industries and companies cannot enjoy the benefits of the denominator decline in the DCF model. Only those companies that are considered to have long-term growth potential have received valuation increases. The theory of diversification is further challenged.

The information revealed by China's annual two sessions (Lianghui) is that as long as the epidemic needs ongoing prevention and control, "Keeping the green mountain and winning the future" will be a better strategy. According to the current fiscal stimulus, the total amount is about 8 trillion. If we consider the economic situation of this year, the pressure on the fiscal collection, and the expenditures for the anti-epidemic measures, in fact, the main increase came from the special purpose debt, and at the same time let go of some capital constraints. If the amount of total social financing is significantly higher than last year ’s target, which was 10.7% growth last year, assuming that this year is about 12%, then the increase of social financing of nearly 30 trillion yuan means that maintenance of our economic stability should be achievable. Even with the cautious mentality of economic subjects, such large scale of total social financing should be able to play a tangible role for "Six Stability" and "Six Guarantee". Therefore, the long-term loss of our economic machine is limited and does not affect our long-term investment.

For the changes in the external environment, there will indeed be many incidents in the short term. In the long run, some basic forces will still work. Although we don't have special insights on this topic, we believe that certain trends will happen in the long term. They include: global supply chain is extremely complicated. So it is difficult to have unilateral threats without harming oneself. In fact, everyone has benefited greatly from the existing system. The difference is that there might be fewer competition before, and there may be more in the future. In the end, new equilibriums will be obtained, even if it's a dynamic one. After a few trials and errors, everyone will know what they can hold and also know the other party's bottom line.

As you know, we invest in both Hong Kong stocks and Chinese ADRs. We believe that for any smart investor who is able to select the best company from one of the most dynamic economies in the world, this is not a charity, but more a kind of privilege. Imagine that if the Norwegian sovereign wealth fund is limited to investing in Norway, it would be difficult to accumulate trillions of dollars of wealth, as it does now. It should be a good example of global investment. We are actually optimistic about the future of Hong Kong ’s capital market. In the long run, the Hong Kong ’s super liaison role is difficult to change. With the implementation of relevant legal measures, a clearer bottom line is in place. The benefit of clarity is that the probability of everyone ’s miscalculation will be reduced. The probability of Hong Kong being more stable and prosperous exceeds the probability of collapse. 

In an uncertain world, the relatively certain pricing power and barriers to entry will be a long-term investment direction, especially when money is abundant. These pricing power and barriers to entry are not necessarily limited to certain industries. After digitization, some industries have shown winner-takes-all situation. While some industries are showing signs of decentralization with the fragmentation of traffic. It increases the difficulty of operation and puts higher requirements on the organizational adjustment for companies. We are relatively optimistic about Internet services, education, consumer companies that have pricing power or are able to cope with new changes. We also like consumer-oriented medicine and medical care, consumer electronics and good quality banks.