A series of government policies announced in late September quickly reversed market expectations. Market sentiment turned out of the extreme pessimism instantly, and China stock market staged an unprecedented rally. From slogan of “cherishing life and stay away from the stock market”, to queuing up to open stock trading account, and some even take leverage to maximize exposure, it only took a week for the market mentality to change. You will miss out, if reacted a bit slow and hesitated. While delighted that the stock market has finally embraced joy after long hardship, we also need calmly think about how to accommodate the rapid changing market.
The economy is the goal, and stock market is the instrument, which could cultivate wealth effect to boost badly needed consumption and investment. The statement of Politburo meeting on September 26th vows to “stabilize” the tumbling property market and to “boost” the bearish capital market, hinting two different key words to those two markets. The stock market reflects economic outlook and also it can have impact on economy. In the past 30 years, the property market has been the main force to bring wealth effect, and now has little room to expand. After several years of contraction, the stock market has been squeezed to a historical low valuation, and the market size of 90 trillion RMB is large enough to replace property market for creation of wealth effect. China's economy is currently facing downward pressure and lack of confidence, which has led to deleverage by both enterprises and households. It is a smart move to stimulate consumption and investment through the wealth effect of the stock market. From this point of view, it is still the beginning of the wealth effect.
The emotion driven rally will soon be gone, and how to position after the market bottomed out is more critical. The rhythm of this round of market rally is unprecedented, and it is dizzyingly fast. By the time you opened trading account and transferred money, the SSEC Index maybe already up to 4,000 level. Whether you can make money in the first round of rally depends on if you can hold position when the market is low, and responds rapidly enough when the rally starts. However, rocketing rally is not the norm. In the case of a large inflows, a long period of active market will be the norm, and a wise response to this new market condition is the key.
There is more upside for growth stocks, and small caps. From the perspective of behavioral finance theory, investors risk appetite will gradually increase as the market unfolds. Growth stocks would perform better in a bull market since they price in more potentials. The current historical valuation quantile of growth stocks is also lower comparing to value stocks. Growth stocks are better choices as market has bottomed out. In addition, the abundant cash influx to the market will provide a good opportunity for the rotation effect of small-caps. After this year's sharp decline, small-caps have a relatively low valuation quantile as well, which is another good choice. Theme investors will return, who are focusing on the theme potentials rather than stock valuations. Technology topics such as semiconductors, new energy, and artificial intelligence are worth paying attention too.
During the market bottoming this year, there was a lot of volatility coupled with extreme movements. We held high stock position under pressure, and investors suffered with us too. Many investors withstood the pressure with us and did not make large redemptions in the later stages of the bear market. In late September, after the policy turned positive, we responded in a timely manner and quickly increased position.
During the bear market, we did not relax research work and actively explored combination of discretionary and quantitative investment methods to prepare for the future bull market, and expanded our investment research capabilities in growth and small-cap stocks. This is extremely critical when a bull market comes. The initial rally will soon pass, and a fluctuating but upward market will come. How to make alpha under the new market condition is the key to accumulate long term returns.
" How to live through the darkest moment" in January, "A bad start doesn't necessarily lead to bad result" in April and "Survive, Do not give up" in July, are the titles of this year's quarterly letters to investors, which recorded a journey we have shared with our clients. When the hardship is fading away and joy comes, I am not only happy and full of hope, but also not forget to reflection and lessons learned.