WE THINK - 2023 OVERVIEW: Winter has passed; Spring is coming

2022 has been a magical year to many, or to some fields of expertise, a very difficult one. Looking back, the market has been mostly bearish, where US stocks has seen its largest downfall since 2008, with Nasdaq falling 33.1%. Chinese stock markets also fell, after recording a three-years consecutive gains between 2019-2021. Wind All China Index fell 18.7%, CSI300 fell 21.6%, GEM Board and Tech50 Index falling 29.4 & 31.4% respectively.  Crypto currencies wiped out about two-thirds of their market value, falling from a total of USD 2.25 trillion to about 810 billion, with Bitcoin seeing over 64% decline. There were structural changes to the capital markets as well – new energy sector has seen headwind, with Tesla falling over 65%. Tesla and Bitcoin has shared commonalities – both have seen rapid rise in market value in 2020 – 2021, then facing a sharp downfall in 2022. Surprisingly, “old energies” like coal and oil were outperformers of the year, with the best mutual fund performer (ranked #1 & 2) in China had heavy exposure in both sectors. Although Rabbit Fund’s overall performance was slightly negative this year, we managed to contain our drawdowns to single digit, and continue to outperform the index by large.

 

Much happened in the past year and we will try to conclude the events with the following keywords: geopolitical disputes, inflation & recession, globalization, foreign affairs, China’s anti-pandemic controls, Chinese real estate market, Chinese economy, global economy, and global capital markets.

 

Geopolitical Tensions

It has been over 300 days since the outburst of the conflict between Russia-Ukraine in 2022. The situation has become out of Russia’s control and initial plans. With NATO’s full support (financial, economic sanctions, military intelligence, equipment, etc.), Ukraine has quickly gained more tactical advantages as compared to the beginning of war. It is now almost impossible for the Russian army to achieve what was initially hoped for without the use of nuclear weapons.


Now that NATO & Ukraine has the upper hand, the next question becomes how to handle the situation without triggering Russian’s use of its nuclear arsenal. This could be one tough task that has no previous experience to leverage on.

 

With the referendum previously took place in pro-Russian states, the current Ukrainian government is unlikely to accept any “peaceful resolutions” with such referendum in place, nor would Russia give up such results of “voted democracy”. Like Vladimir Putin has once said in his new year’s speech, “we either surrender or continue fighting”, a third option might be lacking for Russia.

 

This is exactly how terrifying the war is – you can decide how it starts but never how it ends. We are not Putin and would never be able to guess how is this going to end, admission to failure or progression with the use of the forbidden weapon. Meanwhile, disputes in Korean peninsula, , Iran-Israel proxy conflict, Kurdish-Turkish conflict, the escalating tensions between Serbia and Kosovo… all these are developments of a new world in and after 2022 that could threaten the order that was established for decades. Perhaps, just as said in Ray Dalio’s newest book, “Principles for Dealing with the Changing World Order”, the world has changed and we may not resolve the above conflicts with the previous shared values such as peace, globalization, mutual benefit etc. We only wish that in the new year, leaders from around the world would be wise and bring peace to our planet, avoiding the horrible outcome of a nuclear warfare. The recent attempts of Russian army to sabotage power supply of Ukraine is to hope to lower the will of pro-war Ukrainians to continue to fight this battle. Perhaps this prolonged tactic of suffering is a way out to have both sides stepping down from the ring. 


We do not know how this war would end but would only hope it ends soon.

 

 

Inflation triggers recession – investors beliefs are threatened

This round of global inflation (led by US) has caught many off guards. For a long period of time, market is used to the FED and BOJ quantitative easing (“QE”) measurements, and a weak inflation at place. The first two rounds of the three of QEs (2008, 2011 and 2020) has not seen inflation pressure at all, but why this third round trigger such intense inflationary pressure? Unlike the previous QEs, there were also financial aids provided to the U.S. citizens, which made direct impact on public spendings, driving up prices and thus inflation.

 

From the supply-front, upstream energy prices have been in a bear market since 2015. Companies had difficulties in operating their business and many had bankrupted. Those that did not also lacked the capital expenditure to expand their production line. The industry was further struck by the 2020 periodical sharp decline in gas prices – this has led the financial industries to cut its financing leverage due to the lack of confidence, driving more SMEs out of business. As for coal industry, financial institutions also hesitated its funding towards such companies due to the lack of visibility in “carbon neutral policies”, which again led to many SMEs bankruptcy. The growth of supply-side has been suppressed by the above reasons, thus leaving behind the cause of inflation. We must understand that at the beginning of the transition in new energy, the demand for “old energy” actually increases. and the current inflation is driven by a strong energy price increase.


Rate hike is a must to contain inflation

Rate hike is a measurement used to cool-off the overheated economy (while recession is over-cooling of an economy). Like different seasons in a year, US economy had faced different cycles in the past, at times recession happened as well. We should not fear what’s normal cyclical. Since the sub-prime crisis in 2008, capital mark markets have been booming for 13 years. For those who joined the industry afterwards, it is understandable to feel excited or worried when facing the unknown for the first time. But for those who’ve endured the different cycles, it is just business as usual.

 

The rate hike would not only lead to economic slowdown or even recession, but also comes along with some side effect: 1. Valuation drop on asset prices, 2. USD appreciation, 3. Bursting of asset bubbles. US government bonds are considered as risk-free assets, also the basis of pricing for other asset classes. Now that 10yr treasury has risen its yield from 0% to 4%, many assets would face repricing. Nasdaq, Chinese real estate investments, and Japanese government bonds were considered the three “pillars of belief” in recent years. While the three assets all performed negatively in 2022, it is to our interest to rethink if their previous bull run were based solely because of a low interest rate environment.

 

Globalization and Foreign Affairs

BREXIT and Former President Trump’s election success in 2016 were two events that see the movement of globalization taking a U-turn. People starts to rethink and adjust to the action of globalization. The Russo-Ukraine conflicts has further intensified such debate of whether globalization is actually necessary. The Euro states were firm to withstand the pressure from Russia and replaced their supply for energy with more expensive alternatives such as US and the Middle East. Globalization sped up in 2000 since China joining the WTO, a trigger that led to the world entering and era of “high growth low inflation”. As tensions among countries intensify, just like how Russia’s low-cost energy are prohibited from entering the market, such anti-globalization movements would definitely reverse the course of high growth & low inflation, turning it around into low growth & high inflation for all.

 

Since the US-Sino trade war in 2018, the relationship between major economies has been declining. Although the relationship between China and US has seen less tension since the Democratic Party’s success in 2020 presidential election, the relationship is not as harmonic as before. The importance between US & China economic activities are far beyond those between Russia’s towards Euro States. While it is unacceptable for the Western world to totally decouple its trade relationships in China, COVID has also taught them a lesson that their manufacturing capabilities are overly relying on China, causing disrupts and risks to their own economies. We would expect the US-Sino relationship to be stable, while US strengthening its supply chain management from other countries. On the other hand, areas such as semiconductors, the restrictions and limitations, from equipment to talents, would continue to apply to China, slowing the pace of China from catching up in such high-tech manufacturing fields. Undoubtedly, this would have some negative impacts to China’s market share in high-end manufacturing and high-tech development. But we must also remember that the Chinese possess one of the largest consumption power on earth. While the semiconductor is a market worth about USD 560bn, high-end manufacturing worth about 300bn. Should the supply chain management remain globalized, components could be purchased from overseas and the manufacturing industry would survive. After all, the manufacturing industry in China has been operating under such circumstances for over 40 years.

 

Thus, the most rational decision for our political leaders, and for the mutual benefits of both parties, is to remain an active and friendly relationship between US & China, instead of locking down each another.

 

Chinese Pandemic Controls, Chinese Real Estate Sector, Chinese and Global Economy

We fantasized of the COVID to be over in the beginning of 2022. Shenzhen citizens were used to taking PCR tests every 24 hours, showing the negative results before entering work place or public facilities. At the end of the year, my family and I were infected with COVID. Thankfully, symptoms were light and our family recovered quickly in a week’s time. We managed to dine out on the 30th of Dec and see that the streets are once again filled with people. For three years since 2019, it has been one of the toughest time for every one of us. Lives were sacrificed and companies fell during the period of time, but everything has a cost to bear, especially when considering COVID’s high fatality rate at the beginning, the impact to our society as a whole were managed at its minimal. With now China uplifting its anti-pandemic measures and reopening its gates to the world, we believe that many problems would be resolved with time. Those companies who faced difficulties during COVID would soon see improvements. Although such increased economic activities would not directly reflect into our macro data, these would soon be shown in company’s balance sheets and see more restoration happening across regions and industries.

 

China’s real estate starting falling since 2H21, with an even faster rate of decline in 2022. The first 10 months in 2022 were filled with negative news in the real estate sector. Policies keep rolling out and the peak of the panic hit at the end of October when Chairman of Longfor real estate resigned. Market believes that if the best privately owned company Longfor could not survive, who else could? A round of panic selling followed, and with sharp decline stock prices, we saw a quick turnaround in policies – central bank, CBIRC, CSRC all pushed out policies and guidelines to aid the restoration of real estate sector. Banks provide over 2 trillion credit to the industry to keep an ample liquidity for real estate companies. An unforeseen effort where regulators and financial institutions quickly aligned to protect the stability of real estate industry. And we should understand very clearly that, real estate is an asset held by the majority of the people, with about 60% of total assets held by citizens belong to this sector. In a market of 400 trillion, and a 20% drop would have devastating effects to the whole economy – just imagine how many more jobs or industries are needed to make up such loss. It doesn’t take a rocket scientist to understand the importance of maintaining a stable real estate industry in China.

 

We believe economic activities would continue to slowdown in 2023. IMF has said, “at least one-third of local economics would face recession in 2023, making it a tougher year than 2022.” We agree with such point of view, but we do not think Chinese economy would be that bad (we have aligned views with most economist where GDP growth of China in 2023 should be close to 4.5%). The major reason for such growth is due to the reopening of the country, a now stabilized real estate sector, and government led investment incentives that would stimulate growth in different sectors.

 

Global Capital Markets Overview

We believe the correction in overseas market, especially US markets has released some pressure of the bubble. But it is too early to call it over, under the backdrop of rate hike & USD appreciation. It is recommended to be conservative and let the market and economy really adapt into a rate hike, pricy USD environment (although this kind of environment may not last for the whole of 2023). While it is impossible to predict the actual movement of the stock markets, we see opportunities in assets oversold during the panic-sell last year. From a long term investment perspective, this is a strategic timing that one should not miss.

 

For Chinese capital markets, with enhanced compliance and regulatory requirements in place, we continue to see pressure in some stocks in particular. Nonetheless, the valuation is now reasonable after market dropped in 2022, with some sectors at its trough value. The tonality of China’s policy would be stabilization of economy in 2023, so we believe that marginal liquidity would be kept at an ample condition, resulting in a rather more aggressive economy and capital market activities. And historically speaking, global recession pressure always drives China towards a more aggressive internal investment and consumption stance. As a result, although global environment may not support a bull market, China may become one of its kind in the year of 2023. As mentioned in our yearly overview held annually, for growth stocks with reasonable valuations have a high chance in yielding positive returns. In addition, we believe there are chances in sectors with high dividend yield and lower valuation, cyclical reverse sectors, sectors that benefit from uplift of pandemic controls, and sectors that benefit from policy reversal like real estate.

 

At the beginning of 2023, we would like to wish our friends and clients the best of luck. Technological development has probably outpaced us and have taken the development of our society to a new level. May we all continue to be humble and learn from the new world and leverage our previous experience as an aid to guide us into the unknown but not an obstruction.

 

May all of you and your families stay healthy and happy in the 2023!


 

WU Weizhi

Jan 2nd, 2023


本期《偉志思考》簡體中文版鏈接:

偉志思考:中歐瑞博2023年展望--凜冬已過春回大地

https://www.rabbitfund.com.cn/news.php?act=view&id=515

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