Newsletter commentary Nov 2022丨A bright future ahead

A bright future ahead

The market rose sharply in November. We believe that the major factors that plagued the market have all reached the turning points.

Epidemic control and economic development were rebalanced in China under new conditions. From our perspective, epidemic control is to seek the optimal solution to the toxicity of the virus, the preparation of medical resources, and the people's understanding, needs, and cooperation. The measures were gradually optimized in the past with the changes in the above three dimensions. The overall thinking has been continuous from the past cautious measures against the highly toxic original virus that we hardly know about to the currently optimized adjustments when variants are less harmful, and we know much more about COVID. It's just that China is enormous. When flexibility is given to local governments to explore ways that meet different situations, outcomes may vary. There might be beats or misses on expectations in the short run, but the balance will be reached eventually. An increasing number of cases in the future is no longer a significant risk, while the future mutation of the virus is the only uncertainty. This is the key to the outlook of and the primary source of contribution to China's economy next year. A large number of stimulus measures were only partially adequate this year due to the lack of scenarios caused by the outbreaks. But next year, China's economy will be boosted by the recovery of consumption and services, which will be particularly precious in the context of a downturn of other major economies.    

Overseas inflation has peaked. The market was betting on the peak of inflation in the past few months, but they were all wrong until the stats in October showed that even if inflation is so sticky, it has passed the turning point. However, inflation will only disappear after this point due to its stickiness. The easing speed is uncertain, which is not an issue in the short term but means a lot in the middle run. We are concerned about the 2% inflation target several central banks set. The target might not be empirical nor academic, but out of cognitive inertia. And now the context has changed.

China property has significantly dragged China's economy this year, confusing investors. After issuing individual policies, a package of solutions has finally been introduced recently. We think this is important to stabilize expectations and to avoid systemic problems but it does not address the problem of reduced demand. However, a rapid or gradual decline or a step down will impact the economy and investment differently. We can now rule out the possibility of continuous rapid decline, which is enough for the market in the short term. In the future, we expect that both positive and negative contributions from real estate will be limited. It will not be a key variable.

In addition, we believe that the China capital market will be more investable with the improvement of China economy. Some people used the 80% drop in the KWEB index as an example of difficulty investing in China. Still, on the other hand, no one doubts the investability of US stocks even if META has fallen by 70% within a year. Moreover, some other major tech companies in the US also fell by nearly 50%, but people thought that was due to the interest rate of US bonds, the operating cycle of the companies, or the industry cycle. In contrast, how much of KWEB decline was due to the rising global interest rates or the company/industry cycle needs more analysis. It is usual for rising global interest rates to have a more significant impact on the stocks in non-local markets. At the same time, we see adverse effects on both the industry and company levels. For example, the increase in the e-commerce was largely diverted by the live e-commerce on TikTok/Kuaishou or by Pinduoduo in the past two years. The story of the leading game companies sharply increasing market shares in the high-growth period is over. The overall game market has encountered bottlenecks after benefiting from the epidemic. And the companies have suffered from their success on previous hot launches. Even if the recent masterpiece Genshin Impact was successfully developed by a leading company, it has not contributed much, because any single game is too small compared to the company's size. Our point is that declines similar to the KWEB's were due to changes caused by regulation, global interest rates or business cycle. The most reasons that explain the fall in big tech companies in the US apply to the KWEB. As a cycle, there are downs and ups. We are optimistic about the upward trends of many companies. Meanwhile, supervision also performs a cycle. Regulation has been strengthened after the early stage of development and will normalize after achieving the supervision targets; then the development will become more prominent.

Looking to the following year, China might be one of the few large economies that can grow. The factors that suppressed Chinese assets this year would be reversed or eased, for example, the epidemic, exchange rate, and pressure of capital outflow caused by overseas inflation. Sino-US relation has been set a tone on the bottom line by the two heads of state. The suppression has never been successful with ongoing competition over the past five years, but to make China grow faster. The semiconductor industry is a good example that has significantly improved from 5 years ago. Time is on our side, which has been proven time and again. It may be soon that people realize that suppression is uneconomical and ineffective. Chinese assets would be revaluated at that time but might have already risen significantly.

The most important thing is the continuous optimization of epidemic control. The current situation is optimistic as long as the virus does not mutate adversely. Noise can be ignored. We maintain active investing.