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- [00:03]
A
Hello, everyone. Welcome to the Julius Bear Podcast. This is Richard Tang, the China strategist and head of Research Hong Kong for Banju S. Bear. It's great to have Hong Hao with us again to discuss the outlook for the Chinese market. Hao is a renowned economist, and he's also the Managing partner and CIO of Lotus Asset Management. Hi Hao, thank you very much for your time speaking with us today.
- [00:27]
B
Hey, Richard, Great to be here.
- [00:29]
A
So how during the past few weeks we've seen a very significant pullback in all these AI infrastructure stocks basically around global markets. We not only talk about the US but also different markets in Asia, Korea, Taiwan, Japan, for example, and in China in particular, many popular AI names have fallen, say 20 to 30% or even more from their highs. The driver of this is, of course, first there's this elevated volatility in the Korean memory sector. And then there were also recently some marginal shifts in the AI narrative as well. We already discussed in the last episode about the crowding risk in AI stocks, and I'm sure the audience is not entirely surprised by the correction that's going on right now. But I think what's more interesting is that we've seen, and we've got so many questions about whether we should buy the diplomatic now or should we wait later. And at Julius Berry, we still see the structural uptrend in AI to play out over multiple years. In the near term, the nearest potential catalyst will be when the US Hyperscalers share an update on their capex guidance by the end of this month when they're due to report their Q2 results. Now, if these numbers are reaffirmed or even raised, I think this should help Market to resume its primary uptrend after the current correction. How? I think last time we spoke, you changed to lean towards a more conservative stance for AI. What about now, after the recent correction, are we close to the primary uptrend again, or you think we should wait a little longer?
- [02:04]
B
I think last time we adopted a very cautious stance on the AI names, and many of the Chinese AI names is down like 50%, some even 60%. So there's a very significant correction over a space of less than a month. So I think right now there is a technical rebound going on in Cosby because Cosby has reached a very significant technical level. And also the leveraging process initiated by the Korean regulators may be halfway through. There seems to be a little bit of stabilization efforts coming in as well. So I think overall we commend the Korean regulators efforts to deleverage and rein in the speculative excess in that market. But I think the job is far from being complete as long as the leveraging process continues, then there will be continuing volatility and also some downside from here. So I think right now what's happening is a technical rebound because stocks are very oversold in a very tight space and therefore it all goes well for a technical rebound. But whether people want to trade such a volatile rebound or not, that's a very different story.
- [03:05]
A
How about the fundamental earnings? You still feel confident that that's fine?
- [03:09]
B
Yeah, I think fundamental is sound. There's a joke going on. If the Korean bubble burst right now is the cheapest bubble to burst in history. Right, which is true. Korean market is trading at the lowest valuation multiple in history. It's trading at about 6, 7 times and therefore I wouldn't say that the market is terribly expensive but because stock price overhyped over reflected the earnings fundamentals so therefore there is a technical correction. So I think going forward we still expect very strong earnings growth in the semiconductor sector but then at the same time because capex will come in waves so the first wave is obviously this year. So Max7 put in US$1 trillion into the AI sector and then all the upstream semiconductor chip names starting to benefit. But then once it gets to 2027 then investors would be looking for signs of cash flow return from these investments which I think it would take some time to eventuate and therefore this timing is critical and the timing of many of these AI CapEx turning positive may come later than what the investors are expecting and therefore that could create a sort of an air pocket for many of these names for the time being. So I think the AI revolution is here and is happening. It's going to push productivity growth in the real economy but then at the same time we have to be careful how in the near term the stock price is reflecting all of this.
- [04:39]
A
Fair enough. I guess it doesn't hurt to be a little bit more patient to wait for a better entry level to get into this structural trend again. And for Chinese AI stocks in particular, since we just talked about that, I think in the near term there are still several factors that may affect the performance of these stocks. One is clearly the market sentiment towards the new listings and of course a lot of lockup are expiring in Hong Kong for the recent IPOs and we definitely need to monitor whether that would have an impact on the liquidity and the demand supply balance of the stock market. But talking about the China stock market, I Think it's fair to say that the market is like a seesaw? Why do I say that? The new tech, which are the AI infrastructure stocks, they sit on one side of this seesaw. And old tech, which are mostly Internet and some maybe even older economy stocks, they sit on the other side. So during this year we have Chi next going up 40%, Star 50 going up 60% year to date. But on the other hand, we have Hang Seng tech index down 20, and now we have an AI correction. So money, as you mentioned, how the money rotated to the old tech stocks, that is the Internet, the EV smartphones or biotech, or even the old economy next. So my question for you, Hao, is how optimistic do you feel about the sustainability of this rebound in the old tech old economy sector?
- [06:05]
B
Yeah, I think it would take some time for the rotation to complete, right? Because it will take some time for people to come around and believe that this rotation is for real. It takes some time to convince those people who have been going crazy all in on the AI revolution and therefore completely rejected the old economy names. So all of this will take some time. So, you know, the rotation will hit some road bump zigzagging, but eventually at least part of the money would come back to the old economy names. It has sustainability. And also for those people who firmly believe in AI revolution, I think we are more or less in the same boat, right? So by now everybody should have realized that this revolution is for real. AI can do so many things better and faster than human being, and therefore it's going to have a very significant impact on economic growth going forward. But then at the same time, if you so firmly believe in the AI revolution, then you should also be firmly believing in the old economy names, because after all, after the economic growth and then comes the income growth and therefore there will be consumption growth as well, because your income is expanding and therefore the old economy names will benefit. And therefore if you are an AI evangelist, then you should be believing in the old economy story as well. So I think right now, probably because the limitation of liquidity supply, people have to choose, you know, where is the highest return going to come from in the marketplace. And for the time being they chose to side with the AI names. But I think over the next couple of weeks, then the rotation would become increasingly clear and also it would be easier for people to believe that there are returns to be had in the old economy names, right?
- [07:48]
A
At Julius Bear, the thing that we monitoring is July Politburo meeting and also the upcoming off season, we think that would be quite critical to determine the sustainability of the rebound. To be frank, for now, we're not placing very high expectations on the policy side for a few reasons. First, China do not have a very high growth target. So policymakers may have actually more tolerance to weaker economic growth before they feel compelled to simulate the domestic demand. And second, I think China may be putting its AI capabilities at a higher policy priority. But in any case, what are your expectations on the policy and economic outlook for China in the second half?
- [08:29]
B
Yeah, we just had the GDP number and also other macroeconomic numbers reported today. We're seeing a small dip in GDP growth in the second quarter because second quarter is affected by the Iranian war and also it's affected by very high oil price and also how China curb industrial production to cope with the surge in energy prices. So I think as a result, the GDP growth in the second quarter is slower than expected. But then if you look at retail sales, if you look at the export growth, and also if you look at the industrial production, it's actually sort of in line and slightly ahead of expectation. And so we can see that this economy is still going along with some sectors performing very well. But I think the real estate related sectors are still lagging and also dragging the economic growth. So I would say that for now, because we're still well within the growth target this year of about 5%. So we probably will see policy steady as she goes. We are not expecting immediate sort of policy support from the top. I think, you know, we probably have to go into the third quarter to evaluate the circumstances. But I think right now with things going this way, with exports doing strong, and also retail seems to be coming back because of a better stock market, I would say that we will have better clarity in terms of what kind of policy support that we're going to get going into the third quarter.
- [09:57]
A
Right. And I think you made a very interesting and important point that is now about the divergence of the outlook within the different parts of the economy rather than the whole economy being weak in every sector. And I guess policymakers probably would hold on and observe how the numbers would go on in the second half before they are compelled to ease.
- [10:19]
B
Yes. In the last episode we discussed how the Chinese economy is also a K shaped economy as well. Right. So we were saying that the new industries, high value industries, are doing exceedingly well. But then I think property is still lagging. So if you look at it from a policy maker perspective, it's exactly what you were looking for. On one hand, we're Trying to restructure the economy to make it sort of a new technology driven and also consumption based. But then at the same time you don't want to continue to over invest in the property sector. That is a strategy you want going forward. And here is the result. And the result commensurate with a policy objective that you set out in the beginning. And therefore I would say that right now, even though in the second quarter there is a dip in economic growth, I think it's well within the policy design.
- [11:08]
A
Right. So we've talked about the China policy, the economy, we talked about AI earlier. Let's now talk about the Fed policies because they also have an influence of, I would say almost every single market, including China. And the new Fed chair, Kevin Walsh seems to be leaning towards a hawkish stance, at least from how he spoke since he took office. And that has few rate hike expectations in the financial market. Now there are still a lot of debates between economists, between banks, between investors on whether the Fed would raise interest rates this year. And at Julius Bear, we think the Fed may want to keep rates unchanged, at least for this year. And realistically, I think the market will have to wait until Jackson Hole in August to form a consensus on the rate outlook for this year. But before then, I'd like to ask you how, how do you see the Fed may change with the new chair? Will the way they work on rate policy change? What's the policy outlook for this year and how that affects the asset pricing?
- [12:11]
B
I would say that Kevin Walsh is more hawkish than expected. So he keeps saying that there's still a tolerance for inflation. But then the inflation level in the US has been exceeding the Fed's objective of 2% for six years now. It's been a long time. And inflation for some reason is still not back down to earth. From our proprietary quantitative indicator, we're actually showing inflation pressure is going to build up in the coming months and also July with the sort of flare up of the Iranian situation. Oil price is back to 90, so it's difficult to fathom how that would not translate into a higher inflation expectation. And also the Fed has been releasing liquidity into the economy for a couple of years now, even after the COVID Right. So the Fed continued to pump liquidity into the system. So it's difficult to imagine how that changed into inflation today. I think more likely than not in the coming months we're going to see higher inflation expectation. And also for Kevin Walsh, he is between a rock and a hard place in the sense that if you want to reduce balance sheet size, it's bound to affect the risk asset price. And also because of the repo facility on the Fed balance sheet is so little then if he pursue to reduce the balance sheet size then it's going to put huge downward pressure on risk asset price. Also if he choose not to raise interest rate despite the rising inflation expectation then I think the market interest rate would rise as well because international investors would demand to be compensated for the inflation loss if they buy U.S. bonds. So I think it's between the rock and the hard place, it's difficult to see how either of these policy choice wouldn't affect the market, wouldn't affect the pricing of the risk assets. So you know he is in a very sort of a sticky situation. So you know, let's hope he, you know he has good luck in the coming months.
- [14:12]
A
Right. So definitely fat is something that we have to watch for the global markets in the second half. But I think the other asset that is interesting for our audience is definitely the RMB because it's been very strong. And if we review the performance of the rmb when the US dollar depreciated last year, obviously the RMB appreciated along with other currencies. Now that the dollar started to strengthen again. I think what's interesting is that the RMB has continued to appreciate against the dollar. The offshore CNY is now trading at around 6.77 and how. I recall that a year ago we already discussed that the strong exports will become a fundamental driver for the RMB appreciation. And we just printed 27% year on year growth in exports. So how do we see RMB now? Do you think PBOC is happy with the pace of appreciation and is it an asset that an investor would want to hold for long term?
- [15:10]
B
I think it is an asset that people want to hold for long term. And also a rising RMB bodes well for the valuation of the Chinese assets as well. So I would say that it's a long term appreciation call. I think we have been the first and one of the loudest in the market in terms of RMB appreciation. We started to call appreciation in the RMB in 2025. So now everybody else is starting to come around to our side. Now if you look at the export growth for the past couple of years, China has been making bigger and bigger trade surpluses every year. So I think the trade surplus, the current account surplus is US$100 billion a month. So 1.2, 1.3 trillion US doll, which is phenomenal. This is A number that no one in history has ever seen before and it's set to go even larger. Just look at the export figures in June. So one should be surprised to see the Chinese Yuan continue to appreciate because the Chinese productivity, especially in the export sector and the high value added sector is so much bigger and better than many of the other industrial countries. And if you look at the Chinese nominal exchange rate versus the real exchange rate, the real exchange rate is still very diverged from the nominal exchange rate. And I would argue that, you know, the Chinese Yuan is one of the most undervalued currencies in the world. So I think it's a secular trend that is set to continue for the years to come. For now, I think this year because everyone is so one sided bearish on the US dollar. But the US dollar seems to be finding some footing for consolidation around the level of 100 I think in the next couple of weeks because of risk appetite and also because of the positioning, the US dollar is prone to appreciate in the next couple of weeks and therefore it will curb the momentum in RMB appreciation. But I think such a slowdown in appreciation is exactly what the PBOC is looking for. So I don't think the PBOC wants to see the Yuan appreciating so fast that they start to cut into your comparative advantage. So I think a rising US dollars in the near term curbing the momentum in the Yuan appreciation is exactly what the PBOC was looking for. So I wouldn't say that the pboc would be too surprised to see a temporary strength in the US dollars. I would say that from a trading perspective since we are now slightly below 6.8, we've come a long way from 7.5 mid last year, so I would say that it's calling for a pause for a couple of weeks before the secular uptrend soon.
- [17:48]
A
Yeah, at Julius Bear we also constructive on the RMB and personally I hope there would be more pullback to the currency so that we have better entry level to this uptrend. Anyway, that's pretty much all we have to discuss today. Thank you very much Hal for your sharing. Ladies and gentlemen, thank you for listening and stay tuned for our next podcast. Goodbye and speak soon.
- [18:11]
B
Thanks Rishabh. The information and opinions expressed in this podcast constitute marketing material and are not the result of independent financial or investment research. Please refer to www.juliusbear.com legalpodcasts for further other important legal information.