Chinese stock markets ended 2020 on an upbeat note, with the CSI300 and HSCEI indices up by 13.6% and 14.3% respectively in 4Q20, making China A shares one of the best performing stock markets globally in 2020. The markets continued to rally through January 2021, with the two abovementioned indices up by 2.7% and 4.4%, respectively. These strong performances were primarily driven by expectations of acceleration in both economic and corporate earnings growth in the coming quarters and, to a less extent, improved investor sentiment, as the geopolitical risks facing China and the region diminished with a new US administration taking office, which would improve predictability of future Sino-US relations. Against this backdrop, our Chongyang Dynamic Value Fund posted a gain of XX% in 4Q20 and then another XX% in January 2021.
In this last quarterly newsletter of the year, we would like to make a high-level review of 2020 and a preview of 2021.
n The global stock market performances in 2020 were largely shaped by the Covid-19 pandemic and attendant actions by authorities. Korea, Taiwan, and mainland China, where the impact of pandemic had been contained substantially better than others (e.g., Brazil), saw their stock markets having delivered the best returns globally. The US markets also did quite well despite a rather poor management of this public health crisis, primarily due to the prompt, massive, and effective monetary and fiscal stimuli. In this regard, Hong Kong seemed to be an exception: despite a beneficiary of both abundant US dollar liquidity and solid economic fundamentals of mainland China, its markets failed to deliver positive returns.
n The performance divergence in terms of investment styles across the global markets was remarkable in 2020, influenced in part by the rapid development of extraordinary economic and liquidity cycles. Specifically, defensive growth stocks (e.g., IT, healthcare, and consumer staples) performed extremely well for most part of last year, benefiting from the combination of economic downturn and accommodative liquidity conditions. A rotation into cyclical growth stocks (e.g., consumer discretionary, industrials, and construction materials) took place subsequently, as a V-shaped recovery started to materialize while liquidity remained largely abundant. As favorable liquidity conditions persisted, growth continued to outperform value stocks by a wide margin.
n The shock of Covid-19 pandemic helped crystallize several secular trends (e.g., contactless economy, clean energy) and accelerated market consolidation in traditional industries, leaving a lasting impact on the performance of those stocks involved beyond the influence of top-down cyclical conditions.
n A synchronized economic recovery and the attendant policy adjustment by the authorities among the major economies will likely be the dominant macro theme for stock market investment in 2021. Market participants will likely be constantly debating on issues such as “reflation vs. inflation” and “policy normalization vs. tightening”. We think this will be particularly relevant to Chinese markets, where the FIFO (“First In, First Out”) will be the most likely scenario to play out.
n We are currently bullish on the market outlook for the quarters ahead and have increased the overall risk exposure of our portfolio to a high level since late last year. We expect that Chinese stock prices will be primarily driven by EPS growth in 2021 instead of multiple expansion as was the case in 2020. Our base-case scenario hinges on the following top-down projections/assumptions: i) real GDP growth at 8-9% and aggregate earning growth of total A-shares at 15-20%; ii) deceleration of total social financing growth to 11-12% from 13.3% in 2020, or a normalization of credit growth instead of outright tightening; iii) 10-year treasury bond yields at 3.0-3.5%; iv) no material deterioration in US-China bilateral relations which would have significant impact on investors’ risk appetite; and v) no pronounced strengthening in DXY that is consistent with a strong cyclical recovery of US economy, indicating a generally benign environment for risk assets in EMs including China/HK.
In line with our top-down views and based on our bottom-up stock picking, we have rebalanced our portfolio in terms of investment style and sector allocation. First, while our portfolio remains dominated by cyclical growth stocks (financials, consumer discretionary, IT), we added positions on cyclical value stocks (e.g. mining & energy, industrials) and cut positions on defensive growth stocks (e.g., utilities, healthcare), as the former are expected to outperform in the event of tighter liquidity conditions triggered by a stronger growth. Second, in view of the increasingly crowded investor positions on a small number of large-cap, richly-valued stocks, the prices which have gone up parabolically over the last 6-12months, we have shifted our attention to those less popular, mid-cap names with solid fundamentals and reasonable valuation. Third, we continue to maintain adequate exposure to H shares, as our rationale on H shares, which were discussed in quite some details in our previous newsletters, has finally started to be validated. The unusually dismal performance of H shares for the most part of last year appears to have reflected investors’ heightened concerns about geopolitical risks which have now diminished substantially. Moreover, if history is any guide, in an EPS-driven stock market upturn which we envisage for 2021, H shares tend to outperform A shares.
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