Newsletter commentary Nov 2021

The market was not quite volatile in November. CSI 500 rose by 3.3% while CSI 300 dropped by 1.6%. Investors traded on a weak economy and on a pandemic that seemed hard to be curbed in the short run. Energy, banks and consumer services underperformed. Outperformers were national defense, meta universe as well as “the professional, the special, the proficient and the new”.

Pharmaceutical, food and beverage, property, home appliances, consumer services, non-bank financial recorded negative returns YTD. EV and new energy, chemical, steel, auto, electronics and machinery saw meaningful positive returns. For some underperformed sectors, the valuations at the beginning of the year were too high, and the degree of prosperity has since declined. Prosperity has been the main reason for some sectors to boom, thanks to the short supply. However the phenomenon won’t stay long and the supply-demand relationship will have major changes next year, which has not yet been considered by many in the market.

What were the key factors that have affected the market YTD? First, it was not expected that the pandemic would last for more than two years and still didn’t start fading out. Therefore, many industries were facing weak demand or problematic supply chain, from which some benefited and others suffered. Second, a number of names were affected by the theme of climate change that some couldn’t meet the demand due to insufficient investment, and others saw valuation continually elevated thanks to demand beyond expectation. Third, the shift in policy orientation resulted in the disappearance of some industries and in major changes of the attractiveness of other industries. The professional, the special, the proficient and the new were gaining market shares under the threat of supply interruptions of all kinds, marking progress of the industry. Fourth, property sector encountered new problems. The peak of the industry has passed. Things have been widely different from the past 20 to 30 years when the industry were rising. Fifth, stocks with high valuations in the beginning of the year turned out to be not solid at all. 

What will happen in the future? It seems we need more patience for the pandemic to be curbed. Global inflation can no longer be said to be temporary. Property sector will have an even harder time next year. The booming sectors this year have seen their prosperity declining month by month, not to say the supply-demand relationship in these sectors are changing while the valuations are high.

Under the new macroeconomic management framework, growth remains a target, high quality development and technological innovation become the key, and structural policy tools are the focus of active policy making. Although investors didn’t make much money this year, their demand for stock investment has not decreased. This has become a macro force that drives and provides major supports to the market. Meanwhile, though growth in volume is not as fast as before, progress in technologies is continuous and rapid in various industries.

We are pretty confident in the macro stability of China economy. Although top-down opportunities are not clear for the time being, some bottom-up ideas were identified. Similarly, back to the beginning of the year we didn’t see top-down opportunities such as EV and new energy or energy shortage shocks related themes, and the ideas were clearer later. New clues may be unfolded over time.

Finally, we’d like to share our views on Omicron. This new variant reminds us that after a two-year exhausting battle again the virus, we are not able to eliminate it in the short term, nor can it be treated as a flu. An epidemic far worse than flu will exist for a long time. On the other hand, our capabilities to fight against the pandemic have been declining in various ways, such as people’s caution fatigue towards the Covid-19 or a limited or even void economic capacity to support further anti-epidemic measures. We currently know little about Omicron due to limited information. Whether it is more harmful than Delta needs to be found out through further observation. But it is beneficial for the governments around the world to launch swift non-medical interventions with Delta’s lesson learned.

No matter whether Omicron is more powerful than Delta, it will have the following consequences: First, countries will strengthen comprehensive anti-epidemic measures. Second, countries will be more conservative and long-sighted in their epidemic outlook judgments. Third, policies will be further loosened, or tightening policies be made more cautiously. Fourth, China will stick to a zero-covid policy for a long time and take into consideration the impact of the prolonged pandemic in its decision-making.

In the past year or so, although the epidemic situation was awful, its impact on the financial market was totally different from that on the real world. Under the protection of extremely loose policies, the financial market has been so strong that investors’ attention to the pandemic has been diluted although the situation continued to exceed expectations in a bad way. This had led investors to keep underestimating the severity and long-term nature of the pandemic, as well as the impact of the virus, especially of Delta variant. When Omicron finally grabbed attention with the financial market reacting fiercely, we regard it as investors’ make-up for the previous negligence towards the pandemic, especially towards Delta. Omicron might be different in the way that it may have more negative impact on the overseas financial market than on the pandemic itself, caused by different anti-epidemic measures of foreign countries. In the past, these countries focused more on economic stimulus and less on anti-epidemic measures, which was bad for curbing the pandemic but good for the financial market. With a potentially widespread Omicron, countries will focus more on epidemic prevention with light economic stimulus (there won’t be stimulus policies for the time being) in a short run, which is beneficial for stopping the pandemic but have adverse effect on financial market. Nevertheless, the impact on China would be different as China adopts a zero-covid policy which is effective for preventing any virus or variant. In a short term, the policy won’t change because of Omicron but might be loosened. China will be affected if the overseas situation is bad, but because of the different anti-epidemic strategies at home and abroad, China market might outperform the overseas counterparties facing Omicron.

It will be troublesome if Omicron causes more serious consequences than Delta. After two years under pandemic, countries became more vulnerable fiscally and financially. Constraints have been building up that capabilities and spaces for further stimulus are limited. Risk asset prices will no longer rise but fall. Suppose Omicron turns out to be a false alarm, will the market completely go back? Probably not in a short term. The market has been under-reacting to the epidemic and underestimating its long-term and seriousness. Omicron made the investors correct views on the epidemic, which will not disappear with Omicron fading out. This will have an adverse impact on the market. Omicron as a false alarm might be good for the medium term but uncertain for the long term. Fundamentally, Omicron urges countries to actively prevent the epidemic, which would lead the situation to be improved and the economy and society would return to normal. As everyone gets more cautious about the epidemic, China will be more flexible, and the developed countries will be more prudent on tapering. This will be beneficial to the market in the medium run. In the long term, stimulus measures will withdraw as the economy and society recovers. It is hard to say which will have the greater impact.