WE THINK: Don't be fooled by short-term uncertainties. The hardest thing in investment (14) – understanding the core issue by seeing through superficial

Stock market in February corrected from its high: while the CSI 300 dropped only 2.1% in Feb, the Hangseng Tech Index and Heng Sang dropped 13.99% and 9.41% respectively. Corrections were deeper in popular names, dampening investors’ sentiment and causing diversion in market outlook, which such pessimism were further strengthened with concerns over economy recovery, trade figures showing weaknesses, companies falling below expectations etc. Such pessimism is understandable.

In this chapter of WE THINK, based on the topics mentioned above, we would discuss the typical Spring performance and corresponding investment strategies, what are the short-term obstacles that blocks you from seeing the core issue of matters, and why is such the most important ability we ask for as a research analyst. 

Spring Phenomenon and its true meaning behind

A microscopic view of domestic economy

One observation of most significance is the recovery from real estate sector! A close friend from Chengdu who works in the real estate field, says that Feb new home sales were very well, with first two months numbers almost equivalent to the whole year of 2022. Top 100 real estate companies total sales revenue was RMB 355.8bn in Feb,+15.2% yoy or +27.1% mom. Housing prices we see a slight rise in tier-1 cities and tier2&3 cities price fall slowdown. Based on the industry’s data, optimists would suggest the policies are starting to see its effect, while pessimist believes it’s the last dance of the industry. Nonetheless, a recovery in sales number is definitely better than an ice-age in the sector, beneficial for both industry and macro economy.

Rumors suggested that cargoes are piled up docks and ports, given the backdrop of a weakened export demand (followed by weak export figures). While it might be true that export numbers have fallen below expectation, meaning export demand are still weak and therefore affecting the sector chain as a whole, we must remember that such truth is only partial of what’s happening in China – after the uplift of COVID curbs, traffic jams are as bad as before COVID, malls are filled with people and ridiculous waiting lines in restaurants are just as irritating as before; The economy is a conglomerate. Everyone understands the story of “The Blind Men and the Elephant” and describing the whole picture based on a fragment could be far away from truth. So what’s important is not to fill in the puzzle by different pieces of information, but to see through what’s behind the puzzle – macro-economy has obviously reached its bottom. However, the pace of recovery varies among sectors. It’s unacceptable to rush into conclusion with overly pessimistic or optimistic assumptions based on fragmented information. The diversion phenomenon in real economy is very similar to what we will discuss the later paragraphs. 

New observations from overseas policy, economy, real estate and capital markets

New observations were seen under the FED’s rapid rate hike. Rate-sensitive sectors such as Europe and US housing market has seen rapid cooling, new home sales fell off the cliff and housing prices has seen its first drop since 2008, with some areas like Bay Area in California seeing deeper corrections. On March 2nd, Blackstone’s USD 562 million CMBS default shocks the market. With over USD 900bn AUM, Blackstone is one of the largest private equity players on earth, with its real estate fund BREIT AUM over USD 120bn, making Blackstone the largest commercial property owner in Wall Street. The default was a result of the rate hikes hindering the commercial property segment, making Blackstone unable to raise new CMBS products to cover its old ones. Blackstone has already restricted investor’s redemption for 4 continuous months, with redemption kept at 2% max monthly or 5% quarterly. Arguably, commercial property funds are experiencing shortage on funding – with investors continue to withdraw their investments and failing to introducing new ones to control, such funds may not have other options but to start selling their assets in the portfolio. But who would have the purchasing power to be the buyer of such humongous portfolio? We mentioned to let it rain before making a move, now it seems the bullets have hit its first victim.

We’ve also observed that the latest unemployment rate in US is at its 50 year low. Given the stock market has been performing relatively well in US, we have yet to seen a turn in the hawkish stance from the FED. Then what is the core issue behind all these puzzle pieces? 

A-share Phenomenon

From our market feedbacks, investors are mostly hesitant towards A-share investment: we know that the worst has passed and from valuation standpoint, it makes sense to increase A-share equity exposure. But no one has reached a consensus towards which industry to invest into – themes such as ChatGPT, Tesla, photovoltaic, innovative medicine, semi-conductors, new energy… etc has all been brought under the highlight, and quickly lost steam, testing investor’s patience or risk tolerance. So far, 2023 isn’t that friendly for investors.

If our focus in 2023 is to seek for one sector or company to invest in, then such results may not be satisfactory at all. As our team has always mentioned, you have to understand the real question before solving the problem.

For those experienced investors, we all understand that during the times when market has just passed its bottom, it is impossible for a research analyst to find supportive data to justify an investment decision – when the real economy has barely left its worst timing, what numbers or guidance can a listco give you? But does it mean that we should wait for numbers to show signs or strength before investing? Absolutely not. Regardless of the past 30 years in A-share of past 100 years in overseas market, the market cycle has always shown that stock markets move ahead of real economy. Thus the best timing to invest, is always during the trough of a cycle, but not when it recovers.

So the most important question, is whether you believe that the current situation is a “winter in economy but spring in stocks”. Would you be patient enough to endure the time and pain necessary for your investments to grow?

While most would only believe Spring has come when flowers are opened, experienced farmers would feel Spring’s footstep at the moment ice starts to melt; this we believe is the core issue. It’s most important for farmers to not miss the spring season and starts seeding their plantations. But what we see now, is the “farmers” in the capital markets are hesitating which crop they want to go for and get the best yields and wasting the opportunies to sow the seeds (a mistake that I personally often make in early days). 

Why is it so important to look only into core issue?

Our institutional clients have often asked us, what are the criteria for Rabbit Fund in analyst recruitment: 1) similar values, 2) the ability to see through the superficial and look at the core issue. The first point is simple, we don’t want to work together with people who don’t share the same belief and values. The second point is what we focus a lot into: we are bombarded with micro and macro data everyday from various sources. If you cannot see through the core issue of a question, one would only become an “information transporter”, repeating what’s said or observed from the market. Of course, there would be times of mistake, which is normal and acceptable. What’s important is how we learn from our mistakes and improve.

Investments, especially long-term investments, can only be successful if you understand the core of the business model. So that you can make assumptions and predictions on where it can be in the future. Without such conviction, you would always be affected by market sentiment and cannot yield superb results in the long run.

And I am more keen on believing such talents of capabilities are trained instead of born, being seen earliest during teenage. It might not be easy to sharpen such skills especially for adults. But we do know that curiosity is key driver of knowing more and more. The other talent is being optimistic and self-confident. And to be honest, its not that rare – most privileged college-level graduates possess such specialty, and maybe that’s why investment banks tend to recruit from such schools.

Market Strategy

After Feb’s correction, market is more cool-minded as compared with January, which I think we could actually be more aggressive or optimistic. While most are still hesitating, valuations are still at relatively low levels, we don’t see too much reason to be pessimistic. For veterans the only difference is which crop to grow, and wait for spring to finally unveil itself.

After the valuation restoration in Nov 2022, we would soon face the earnings result announcements, which should give us a better picture on the well-being of each sector. Guidance and earnings would be the key indicator for the next wave of investors inflow, and holding on to companies of confidence is key.

Once again, our goal for now is not to hit-n-run. Spring is not for harvesting but planting. When the market is filled with noises to sell at high and buy-back at low, this is probably one of the best signs to buy and hold quality names.

WU Weizhi

March 5th ,2023

本期《偉志思考》簡體中文版鏈接：

伟志思考：不畏浮云遮望眼 投资中最难的事十四----穿透表象抓住问题的本质