Market Review: Domestic recovery is weaker than expected; The US recession that was expected did not happen; Rate hikes have not ended but the valuation falling has ended.
Looking back on the first half of the year, the domestic situation was more pessimistic than we expected at the beginning of the year. At the beginning of the year, we believed that residents had accumulated nearly 4 trillion yuan in excess savings since the outbreak of the pandemic. As housing prices fell, down payment ratios decreased, and mortgage rates fell to historical lows, residents' ability to buy houses was actually improving. If confidence could be rebuilt, real estate consumption and investment were more likely to be better, and other aspects of the economy, including consumer spending and corporate investment, would also improve due to restored confidence. And “rebuilding confidence” seemed to be the focus of the central government’s work at the beginning of 2023. However, at the end of February and the beginning of March, we found that the economic recovery was weaker than expected. This partly reflected the central government's intention not to solve economic problems through stimulus measures. And local governments, faced with reduced fiscal revenue and the gradual exposure of debt problems, found it difficult to boost the economy through leverage, and instead faced deleveraging pressures. On the other hand, it reflects that the restoration of confidence among enterprises and residents, without external forces, naturally requires more time for repair. Coupled with some long-term problems that have not been resolved, the restoration of long-term investment (especially private and foreign investment) by enterprises and consumption investment by residents are not so obvious. In the following months, real estate, automobiles, consumption, etc. all showed a trend of weakening recovery and intensifying industry competition. Relatively speaking, AI has shown great potential for improving productivity, driving companies to actively invest and participate, and is one of the few highlights. Some upstream hardware suppliers have already benefited from the global AI arms race.
The situation in the United States is much better, with the economy generally better than expected, and the pace of rate hikes has slowed as expected (although rate hikes have not ended and the rate cut cycle has not yet arrived). Specifically, the recession that the market was worried about never occurred, employment was particularly good, consumer data was differentiated in structure but overall also showed resilience, and inflation began to fall but not as fast as expected. The Federal Reserve has clearly slowed the pace of rate hikes, because on the one hand, inflation has started to show a decline, and on the other hand, local financial risks have begun to emerge under high-interest rates. In the first half of this year, interest rates were raised three times by a total of 75 basis points, and the benchmark interest rate rose from 4.33% to 5.08%. In comparison, interest rates were raised four times in the second half of last year, by a total of 275 basis points. The marginal increase in interest rates this year has significantly narrowed. Overall, last year's rapid and substantial rate hikes led to market valuation falling, and although interest rates are still rising this year, the 10-year Treasury yield reflecting the risk-free rate has generally fluctuated between 3.3-4%, and the risk premium has fallen somewhat, so the overall market valuation center has ended its decline.
The structural situation is somewhat better, a typical example is AI. AI opportunities have brought hardware and cloud computing opportunities to end the cyclical downturn/slowdown of the industry ahead of schedule, providing significant excess opportunities. AI computing power leaders were very much ahead of expectations in Q1 financial reports and guidance for Q2, reflecting everyone's optimism about the prospects of AI and participation in early investments and the arms race. Software and cloud service leaders, represented by Microsoft, have also launched various AI Copilot services and are expected to gain incremental users and higher charges. If the application and commercialization of AI can be achieved, it means that investments in computing power and other aspects will be sustainable and keep growing. The iteration of computing power will also bring about the demand for upgrading and increase in usage of various hardware, thus bringing various investment opportunities.
Market Outlook & Investment Thesis: relatively more optimistic about overseas investment opportunities
Our view on the market and investment thesis for the second half of the year has not changed directionally. We are relatively cautious about domestic investment opportunities, reflected in higher risk premium requirements in valuations, and fully considering the intensification of internal competition issues, real estate and local debt risks, and the impact of household and corporate balance sheet repairs in the context of a downward adjustment in economic growth. We are relatively optimistic about overseas investment opportunities, and will devote more research efforts.
The population is reaching an inflection point, the policy goal of “safety & stability” takes precedence over “growth”, and various balance sheets are shifting from expansion to contraction... These factors pose a risk that China could become a “large-scale Japan” in the medium to long term. This logic seems to have been widely discussed and has become a consensus, but if this risk becomes a reality, the current pricing is very insufficient. Therefore, we will be more cautious in looking at domestic investment opportunities, paying more attention to whether there is a possibility of industry pattern improvement in the context of industry growth slowing down or even stagnating, whether companies have a sustainable competitive advantage, and whether they can improve profitability and strengthen shareholder feedback through efficiency improvements.
Overseas, although there is short-term uncertainty, such as how high the Federal Reserve's interest rate hikes will be, when they will cut interest rates, and by how much, overall valuation risk is not significant. More importantly, benefiting from the global supply chain restructuring, AI innovation, robots, etc., some countries are expected to see an upward adjustment in their long-term growth potential. In the short to medium term, some industries have emerged from the economic downturn and have seen continuous structural growth opportunities under incremental demand, such as the AI field. Some industries that do not seem to be growing fast have also seen companies that focus on niche growth opportunities, such as chain catering and sports brands. Additionally, some industries have shifted from pursuing growth and expansion to improving quality and efficiency, and with the empowerment of AI, expense ratios have already begun to decline significantly and there is still a lot of room for future reductions, thereby bringing opportunities for profitability improvements.
Looking forward to the second half of the year, we still believe that AI may be the most important source of growth opportunities for this year and for a long time to come, and this is true for both China and the US. AI's labor substitution and empowerment in mid-to-high-end industries have crossed the chasm, and have gradually crossed the stage from 0 to 1. In the long run, it is a market opportunity of the trillion-dollar level. During this process, everything from AI infrastructure to AI applications will benefit. On the one hand, it brings opportunities for the strong to become stronger, and on the other hand, there are opportunities for pattern reconstruction.
The main areas currently focusing on:
1. AI: This is the most significant structural growth opportunity in the future, mainly focusing on semiconductors and cloud computing for now, while also paying attention to the development of applications;
2. Overseas cloud computing investment opportunities: We are optimistic about companies serving large and medium-sized enterprise customers and niche markets with a good competitive landscape. The combination with AI can enhance efficiency and increase user value.
3. Structural growth opportunities in semiconductors: mainly focusing on the opportunities related to advanced processes, and AI will accelerate industry growth.
4. Overseas travel and tourism service platforms: Investment opportunities benefiting from the increased share of personalized demands in travel and tourism.
5. Structural growth opportunities in the financial payment field: mainly focusing on monopolistic companies with strong network effects.
6. Domestic service industry: Investment opportunities with steady growth, value reevaluation, and continued dividend gains, represented by property management and vocational education.
7. Internet platform companies with good growth prospects and reasonable valuations.
8. Branded consumer goods: companies with good development prospects and reasonable valuations.
9. Electric vehicles: We are optimistic about companies that can establish long-term sustainable competitive advantages, but the short-term industry landscape deterioration has not yet ended.
10. Defense: Demand is unrelated to macroeconomics and will benefit from future great power competition, and the low correlation with other investments can reduce portfolio volatility.
11. US Treasuries: will benefit from future inflation decline and interest rate normalization, making them low-risk assets that are better than cash and different from stocks.
If there are other directions that meet our standards, we will be happy to include them as well.
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