Market review
In the domestic market, the epidemic occurred frequently in various places in October, which continued to cause some disturbances to the economy. Although real estate sales have recovered slightly, the recovery is not enough to reverse the cash flow deterioration of private enterprises in real estate. As a result, the industry has not yet gone through the predicament, which remains a drag on the economy. At the October conference, the 20th National Congress pointed out that it is necessary to develop "Chinese-style modernization". Compared with "centering on economic construction" in the past, future development will pay more attention to balanced growth and security. It is foreseeable that the past economic growth rate may not be sustainable in the future, and there will be some structural changes in the economy. Investors need to readjust and adapt to the paradigm shift. Both A-shares and Hong Kong stocks have fallen, especially Hong Kong stocks have been hit harder under the influence of foreign capital outflows.
Overseas, the market started to pay more attention to the impact of economic recession expectations on the company fundamentals. Some leading indicators of inflation continue to fall, which further implies that inflation has peaked. Although the Fed is likely to continue tightening to consolidate the anti-inflation achievement, it is expected to see the highest interest rates in the first half of next year. In addition, given that the economy has slowed down and a recession is likely to happen next year, even if the Fed continues to raise the target interest rate, there is not much room left (although the target interest rate has been raised to above 5% after the recent FOMC meeting). Then if inflation can fall back to the target level of 2-3% in the next 2-3 years, the 10-year treasury bond interest rate will fall from the current level of above 4% to about 3%, and the market valuation level will increase, even if it does not increase, there is not much room left to fall at the current level. In the future, fundamentals will replace valuation as the core variable of stock price. The company’s performance continues to differentiate. Judging from the recent third-quarter reports, on the one hand, more companies have been affected by the economic slowdown. On the other hand, some companies whose stock prices have fallen back to the level before the epidemic have bottomed out and started to grow again.
Outlook & Investment Ideas
Domestic
Considering that domestic development will pay more attention to non-economic goals such as safety and controllability in the next few years, both the economic growth target and the direction and mechanism of resource allocation may be adjusted, thus our domestic investment will still focus on structural opportunities. In the short term, what can bring significant changes to economic growth may come from changes in the macro leverage level and adjustments of epidemic prevention. The former is difficult to predict and we focus on response promptly, while the latter depends on the weakening of the virus and the maturity of the domestic epidemic prevention and treatment system, which may not happen until Q1 next year at least. Generally speaking, we are still actively looking for undervalued structural opportunities such as new energy and defense fields. If we can find companies that meet the investment criteria, we will be happy to participate.
Overseas
We maintain the previous judgment, believing that fundamentals are the core driver of future stock prices, and the overall market valuation level is fluctuating between the "top and bottom". The current benchmark scenario is that the U.S. enters a weak recession next year, but an economic slowdown/recession has significantly different impacts on different companies. Our goal is to identify companies with strong competitiveness, sustainable growth, and less sensitivity to recession or sufficient valuation downgrades.
1) Still believe that inflation is probability peaking and starting to fall, but the rhythm and magnitude are difficult to predict.
Although there are structural factors that may cause the medium- and long-term inflation to be higher than in the past, including the global supply chain restructuring from "efficiency priority" to "safety priority", and deglobalization caused by the competition and conflicts of interest between countries. But there are also other structural factors to reduce inflation, such as alleviating labor shortages by improving labor efficiency/replacement of humans (including cloud computing, robots, etc.). In the short and medium term, inflation in the United States will be eased: 1) The high inventories of global finished goods will lead to a decline in demand and bring about deflationary forces in the near future; 2) Rents have begun to peak and fall, which had led to high inflation previously; 3) Unemployment is still at historically low levels, but as the service sector has now returned to its long-term trend line, which is labor-intensive and the latest to recover, while the labor market in other industries has cooled down, it probably means that the most labor-shortage moment has passed.
2) Regarding interest rates and valuations, the main stage of systematic devaluation has likely passed, and the key is the fundamentals in the future
Considering factors such as population and productivity, it is difficult for the potential growth rate of the U.S. economy to exceed the level of about 2% since 2010. If inflation is believed to fall back to the level of 2-3% in the future, the long-term interest rate that affects the valuation should be at 3-4%. According to the Fed's goal, the benchmark interest rate will reach as high as 5.1% next year, the long-term target interest rate is 2.5%, and inflation will fall to 2%, so the interest rate of 10-year US bond should not exceed 3%. If liquidity risk is not triggered, the current valuation has already factored in the expectation of interest rate hikes. So the core driving force for stock prices in the future will shift from valuation to fundamentals.
3) Under the same macro, different companies show different resilience
Structural differentiation can never be overemphasized.
Confronting the economic slowdown, the fundamentals of US stocks are obviously differentiated. For example, the overall growth rate of sporting goods is slowing down, the inventory pressure is increasing, and there are more product promotions. However, the field research data of the athleisure brand leader demonstrated strong toughness that was not affected by the whole industry. Another example is the consumer chips, which was affected by the demand reduction and inventory adjustment, but now the inventory correction is coming to an end, the industry competitive landscape change and the node upgrading may enable some companies to take the lead in going through the bottom.
Hong Kong stocks: still too underestimated, maintain a bullish view, but operations will pay more attention to factors that follow the trend such as prosperity. Our views on Hong Kong stocks remain unchanged. As an offshore market, Hong Kong is easily affected by various factors and is more volatile, making it very difficult to invest on the left side. The way to deal with it is to not only consider whether the company's investment opportunities are underestimated, but also take into account more "following the trend" factors, including the degree of prosperity, expectation differences, and so on.
U.S. stocks: the maximum valuation disturbance has passed. We can find many companies with strong competitive advantages and global expansion opportunities. After taking the macro disturbances into account, there are still a few companies with strong fundamentals and reasonable valuations.
A shares: Under the same stock selection criteria, there are relatively few opportunities, but more research efforts will be made in the areas that meet the national development direction.
The main directions currently focusing on:
Investment opportunities in overseas cloud computing. Optimistic about the segments serving medium and large enterprise customers and having a good competitive landscape, which are the rigid demand that is least susceptible to macro impacts.
The structural growth opportunities of semiconductors. We are mainly optimistic about the semiconductor opportunities related to advanced manufacturing processes, and the short-term economic impact provides a good buying opportunity.
Investment opportunities for overseas travel platforms in the post-epidemic era.
Structural growth opportunities in the field of financial payments. We are mainly optimistic about the monopoly companies with strong network effects.
Domestic service industries: investment opportunities that have long-term growth but are seriously undervalued such as property management and vocational education.
Internet platform companies with great growth potential and reasonable valuation.
Branded consumption companies with good development prospects and reasonable valuations.
New energy vehicles: optimistic about segments/companies that can build sustainable competitive advantages.
National defense: the industry demand has nothing to do with the macroeconomy, and will benefit from competition between major powers in the future. A low correlation with other investments can reduce the volatility of our portfolio.
U.S. Treasury bonds: will benefit from the future decline in inflation and the normalization of interest rates. It is a low-risk asset that is better than cash and different from stocks.
We will be happy to include other directions that meet our criteria.
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