CIO's market view (part of 1Q2018 investors call conference note)

Hello everyone, this is CIO from Golden Pine. I really appreciate all of you for making time in your busy schedules to attend today’s conference. This is the first time we organize such a teleconference. I hope such direct communication would be helpful to you.

First I’d like to share some top-down views with you. In this morning, Chinese government just released the Q1 economic numbers. In general, economic growth was kept at a moderate pace on sequential basis in 1Q. Real GDP in 1Q18 growth came in at 6.8% YoY, flat from 4Q17. It is generally in line with the market expectation. However, the tighter-than-expected fiscal and monetary policy settings in 1Q2018 may have introduced some uncertainties for cyclical momentum in the short term, esp. from March. The nominal growth slowed in both secondary and tertiary industries, with the former driven by more muted PPI inflation. However, from the medium-term perspective, we still hold the view that China is at the early stage of the reflation. The “mini-cycles” in macro policy will unlikely reverse the medium-term trend because such active controlling is more for the long-term benefit of economic structure. Furthermore, over the past years the fiscal and monetary policy in China has become more responsive to growth impulse, which proved to be effectively to curb the downside of growth “soft-patches”.

Another topic frequently discussed in recent is the US-China trade friction. We don’t know much more than you in this but we are also pay attention to it. I think this will certainly last for a while and be a process full of negotiation and bargaining. Let’s keep an eye on its progress. In general, I think now is not the time to be panic. On one hand we don’t have much position in current portfolio on companies which business are exportation-oriented. In the worst scenario, if the trade friction did cause China economic growth to decelerate, the government has capability to hedge it by stimulating domestic consumption. In the end, it is the fundamentals of each individual company that decides the long-term return to investors.

So we will continue to monitor the macro numbers and the change from policy side, and keep evaluating their potential impact on growth and inflation going forward. Regarding our current strategy, I think the opportunity in this year will be more structural, and the volatilities will benefit the performance of hedge funds like us. Start from Feb we’ve gradually reduced the net exposure by utilizing more shorts and pair trades than 2007, because we are facing more economic fluctuation and policy uncertainties in this year. However, this doesn’t mean the current market valuation is not attractive. For some sectors, the market certainly underestimate the long-term return before of the short-term headwinds. At some moment in this year, I believe we will have a very good chance to buy high-quality companies at pretty cheap price.


Q1: As CIO said the overall economy is slowing down which may affect the cyclicals, are you changing your views or turning bearish to any specific sectors for the next few months?

A: This is a very good question. In general, I believe we are still in an upgoing trend of commodities in a long run. The most important thing is the balance between supply and demand. In the long run, the supply side had a more important impact. In the short term, the demand could be more volatile and easily affected by the government policy in investment and the seasonal effect. Based on the economic data released this morning, we see there is obvious contraction in production since march for commodities like coal and steel. So the supply are still pretty disciplined. I normally won’t worry too much about the longer-term return in these sectors unless I see risks in overcapacity may happen.

So there is difference between the current cycle and the last one in 2010-2013. In 2011-2013, the producers in almost all manufacturing industries in China were expanding their capacities madly. That costed almost 5 years for those sectors to get back to a healthy pattern of supply and demand.

Moreover, we will be stricter to evaluate the intrinsic value of these companies, by taking more conservative assumptions and targeted price. For instance, I’d taken the major profits in coal and chemical sectors since Feb, as the stock price soared a lot and rapidly reached our target price in next 6-12 months. Now we see the fundamentals did not change much but the valuation becomes more attractive. We probably will add back some of those names before the demand picked up again in summer.

Q2: When you said the demand may pick up in May, could you share what is the driver? Is there any reasons particular?

A: It is more about the coal and construction materials when I talked about the demand pick-up in May (more electricity consumption in summer). Actually by my observation, during the past two weeks the demands in other materials like steel, cement have already picked up. Changes have already happened. We still need to observe the sustainability in recovery. So far we did not see any substantial changes in the supply side. And the change in demand in the short term has happened mildly. We expect to see more opportunities on cyclicals in the future.

Q3: Could you please give your views on other sectors?

A: Well. We also have some significant positions in consumer and financials. As mentioned in the last month newsletter, we remain optimistic about the companies which can follow the trend of consumption upgrading. What we saw is that the consumer companies with strong brand will continuously benefit from expansion from tier 1-2 cities to tier 3-4 cities, and the room for such growth are huge. We use more bottom-up investigation to analyze these companies.

As to the financials, I prefer more on banks than insurance right now. Some of the 2nd tier banks (joint-equity banks) have been heavily undervalued over the past two years and traded at 0.6 times P/B and 4-5 times of forward P/E, for instance. Now I believe the worst time for them just passed, and the previous pains had been priced in. In recent, this is improvement in inter-bank liquidity. The net interest margin of these banks is keep going higher since 2017. Therefore, the valuation of joint-equity banks is likely to be restored in the next one or two quarters.

We did not change our positive view to the insurance sector for the long run. But in short term, insurance company will face some short-term problems. Their premium growth in this year has already significant slowed down. The second is the uncertainty in interest rate. In the second half of this year, we probably can look back at the sector. The valuation has been attractive after the correction on a historical basis, but we better wait for a while for more catalysts in the fundamentals.

On utilities we have some change in viewpoints and have built positions of wind power into portfolio. From top-down perspective, I don’t think we are facing the change from inflation to deflation, but the Chinese treasure rate likely peaked in Q1 in this year. From bottom-up perspective, we see some structural opportunities. We see the wind power benefits from the undersupply of thermos-power in the first quarter of this year. In the first 3 months of 2018, China’s wind power generation increased by more than 30% nationwide. Because this wind power companies have high operating leverage, their profit growth could be even higher than the topline growth. These stocks were currently valued at 6 times of 2018 forward P/E and 4-5% of 2018 ROIC, which may offer 20%-30% of upside potential.

You may also find our sector views in our monthly newsletter. I’ve just took this chance to elaborate more on that. Thank you for your attention!

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