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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 Van Julius Bear. It's great to have Hong Hao with us again to discuss the outlook of 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 again.
- [00:27]
B
Hey Richard, great to be here.
- [00:29]
A
How the question I got the most in recent days is simply why China market underperformed, even though when you look at the us, Japan, Korea and Taiwan, these indexes have all done very well. Now of course the Chinese market did not drop year to date. The CSI 300 index still gave a positive return of 5% and the Hang Seng index has gained 4%. But when you compare those to South Korea at 75% year to date gains, Japan 25, Taiwan 45, that's still very significant underperformance. Now I suspect one reason may be the sectoral or thematic composition in the market because right now the AI rally is very much concentrated on the infrastructure stocks, for example, the semiconductors, the memory, the optical communication, etc. And these stocks carry heavy weights in the stock indices in Japan, Korea and Taiwan. But they are not as important as in the main board Chinese indexes such as CSI 300 or the Hang Seng Index, and in particular the Internet stocks have heavy weights in the Hong Kong market. So arguably those stocks drag down the overall index performance. But beyond this reason on the market composition, what may be the other reasons that the Hong Kong Chinese markets underperform? And more importantly, when can we really, really expect a better momentum from them?
- [01:54]
B
Yeah, well, I believe these indices that have been closely followed by foreign investors have been measuring the wrong part of the Chinese economy because most of the components of this index are all economy stocks. So they tend to be larger, have much bigger market cap and trading volume. But then at the same time, they represent an old traditional part of the Chinese economy. While the new Chinese economy are concentrated on AI, semiconductors, robotic companies, biotech companies as well, many of these companies are generating phenomenal earnings growth and showing significant earnings growth potential as well. And yet they are being underrepresented in this traditional indices that is being followed by global investors. And so as such, if we look at these indices, you know, we're measuring the traditional part of the Chinese economy and therefore we get a false image of how well the Chinese economy and the Chinese market is performing. Right? So you know, many of these companies, they're having a paradigm shift from zero to one, you know, from loss making companies transforming into profit making companies and they are experiencing exponential profit growth. So if you look at many of the new companies that got listed on the Hong Kong Stock Exchange this year and since last year they all did very well post IPO. Many of them have registered multiple hundred percent of gains on the second day of 5 billion, continue to do well after IPO. So I think if you look at an index of this newly listed companies that is representing the newer part of the Chinese economy, then you will find a comparable or even better market performance relative to the US peers. Of course you know the South Korean market has gone crazy because much of the performance is being generated by the semiconductor names such as Samsung and Hynix and all that. We have never seen this kind of stock market performance as well. So to say that the Chinese tech companies are doing exceedingly well is not to brush off the phenomenal performance that is being generated by the Korean economy and also the Korean semiconductor names.
- [04:02]
A
Right. And I think you mentioned something which is really interesting, which is that the indexes that we look at may not be really representing a full picture of the economy. One example I definitely would raise is the Chinese index because even though that the Asia main board index, CSI 300 or shanghai. Com, they were basically doing very little year to date, the Chinese index was up 20%. I think that's a very compelling number. And the major constituents of the Chinnas index in China, by the way, now they have the China's version of Max 7, basically the top seven stocks in the index. And if you look at which sector they are in, three of them are in the optical communications. And this industry has been so popular among domestic Chinese investors in recent months. And then the other companies in AI, PCBs, energy storage, etc. So definitely the popular side of the AI complex. And on the other hand, the Hang seng index is down 7% year to date. And that's because Internet are the heavyweights. And I think it's not an exaggeration to say that this trading pattern is actually very similar to what US is trading right now. So I would say that what's happening in China is basically the same trade happening in the U.S. now the question is we all know right now the market favor AI equipment, semiconductors, et cetera. And then the large scale hyperscalers underperformed a little bit. Do you think AI equipment rally will have more to go in the Chinese stock market in particular and maybe the US market as well yeah, I think
- [05:45]
B
firstly the semiconductor cycle is a global cycle. So I think many of the Chinese names are having a valuation con when they try to evaluate a company that is turning from profitless to profitable company. So they can't simply use valuation multiple such as P or ps. They have to use a comparable evaluation to compare the companies listed here to the companies that is trading in the US because those are more mature names, they have a longer track record, they're being followed by a bigger group of investment communities and therefore they probably have a better informed valuation number. So that's why, you know, many of the Chinese investors tend to use US companies valuation to evaluate the companies here. So you know they have Nvidia in the US therefore you have the Chinese Nvidia which is the Capricorn that is listed on the Chinex. And also I think important change are coming for Chinex as well. The Chinex index futures is going to be introduced in the Chinese market. This is a significant change. So think about this, right? So the authority is trying to let people add on leverage when the Chinex index is nearing its all time high. And then at the same time many of the Chinese components are generating phenomenal profit growth that is being reflected in the surging stock price. So I think all in all because fundamental is improving leverages, improving sentiment is very strong. I think in the next two months or so the probability of the chainx index making all time high is very large.
- [07:23]
A
Yeah, and I think what's so special about investing in China is that you really need to specify which index you are investing in. That's right, because the returns really diverging. As you mentioned, China Starboard versus Hang Seng Tech we're talking about almost 30 percentage point of difference. So I think this is one thing that is unique.
- [07:43]
B
Yeah, you can just compare the Shanghai composite with the Shenzhen composite. So Shenzhen Composite outperforms substantially.
- [07:49]
A
Exactly. So I think this is one thing. I do want to bring it up to global investors who are most likely the audience of this because if we look at the most popular indices, it really feels like China is moving nowhere. But when you look at that stock by stock, there are really a lot of exciting stories and a lot of exciting rallies happening in the Chinese market. Now besides the sectoral or thematic focus we just talked about new economy versus old economy, semiconductors, etc. I think one small thing that I want to touch on in this episode of podcast is that some investors in the Chinese market are also waiting to see what will happen to the China visit of US President Donald Trump. Now, interestingly, in my recent conversations, investors do not seem to have much expectation about it at all. And the baseline scenario of most people, when they ask, is simply maintaining the status quo and they do not expect much positive headlines. How about you, Hal? Is there anything that's worth attention in your view? And then looking ahead as the US Midterm election is coming, how likely would Trump play that China card again and be hawkish on China?
- [09:03]
B
Yeah, I think the investment community is not talking much about Trump's visit because Trump has exhausted its credibility in the past few years. Basically, the techo trade is on and it's going even stronger than last year during the Iran war. And I think that is the reason why the market globally is making new high despite the Iran war is still ongoing. So I think that's for one. And I think secondly, if you look at the Sino US relationship, one has to ask at this stage, is there more for China to gain from this relationship or is there more for the US to gain in an age where AI is going through the roof? So to make all these semiconductors, rare earth is a key component. And if China stop exporting rare earth, the Chinese Production is about 80 to 90% of the global rare earth supply, then you can imagine the AI revolution will come to a screeching halt. So I think at this stage, there's a lot more for the US to gain from this relationship with China. And I think the US should try all it could to mend the relationship for the better. I think also in this Middle east conflict, I think China really showed its hand during this conflict. Basically, China has been the mediator, a very important mediator during this war. And also I think China make a very positive contribution for this war not to spill over to escalate to a much worse regional conflict. I think China contributed substantially to this. So if you look at the schedule, the Iranian diplomats are in China right now talking to Chinese officials. And then at the same time, Trump is going to arrive a few days later. You know, this sort of a time sequence. And then also yesterday there was a major breakthrough in the situation of the Iran war. So I think both sides are agreeing, basically de escalating their tones. Right? So Iran is guaranteeing safe travel for ships through the strait. And also Trump is calling off the Freedom Navigation project. So all of these are signs of de escalation and all of these are happening when the Iranian diplomats are in Beijing and Trump is scheduled to arrive a few days later. So that is telling you plenty about what is going on behind the curtain. So once again China is making very positive contribution to the situation and we are hoping that the situation will resolve nicely peacefully. All these examples are telling you that at this stage there's a lot more for the US to gain in this relationship than the other way around. And one would expect that China would buy more soybean. So the soybean future is already making new highs. China is probably going to buy more airplane from Boeing, probably more collaboration on the technology front. But in return I think the US is going to ask for more rare earth exports because of all this demand to make all these chips. So if you don't have rare earths, you're done. Basically stop talking about the AI revolution anymore. So I think there is going to be a fruitful discussion. I think China will buy some stuff and the US want to guarantee the supply of railroads amongst the other things, probably de escalate the Iranian situation a bit more. But the Chinese recognize that the US presidential term is only for four years. So in less than 18 months we will be dealing with a new US president again. So I think this transient president position basically is making the Chinese more confident when dealing with the US counterparts.
- [12:44]
A
Let's see what happens when the two presidents meet and hopefully there will be some positive surprises the two men can bring to the market. Now the reason I asked about Sino US relations in particular is simply that exports have become a very important contributor driving the Chinese economic growth. And obviously if you look at the data of exports, Chinese exports to the US indeed dropped a little bit year on year. But the exports to the other countries and the other regions have gained quite materially. And when we meet companies in China, a lot of management is placing the same strong emphasis on overseas expansion as a key strategy for growth. So how do you think this so called going global trend will continue? And let's say export strength is maintained, will this remain a significant driver to support continued appreciation of the rmb?
- [13:41]
B
I would say so. I think the trend of RMB appreciation is very self obvious. Right? So China has huge forex reserve manufacturing sector is grabbing market share globally. And also the real effective exchange rate of the Chinese Yuan is still substantially underappreciated despite the nominal Yuan has appreciated so much. So all of these are calling for a significant Yuan appreciation. And one shouldn't be surprised to see an epic appreciation at the end probably go through 5 starting with 4 handle for the Chinese yuan to US dollar currency exchange rate. So I think to me this is probably the most obvious and most certain trend in the capital market globally. And the Chinese yuan, despite recent appreciation, is still one of the most undervalued currencies in the world. I think for China and also for the US the yuan is sitting at a very intricate sort of balance between the economic relationship between the two great powers. So the US want to bring manufacturing sector back to the US to do that, it actually needs a weaker dollar so that the US manufacturing sector can export nicely on the back of a weaker currency. And then at the same time, the Chinese authorities want to restructure its economy towards a consumption based economy. If you want to do this. A stronger yuan would make it much easier for this transition, in a sense that a stronger yuan would increase domestic buying power for Chinese consumer. And also in this new age when China still has to import much of the commodities from foreign countries, a stronger yuan would make it better for importers of commodities to import all the raw materials into China to make other stuff. So I think a stronger yuan and a weaker US Dollar is in the best interest for both countries. And if so, then it will be one of the important topics that they should discuss during Trump's visit to China. So I think this year we're looking at a six and a half. Right now it's 6.8. I think last year when we were looking at 6.8, when the yuan was at 7.2, we are already sort of out of consensus. And I think this year, more likely than not, we're going to get to 6.5 and then appreciating Chinese Yuan is going to be beneficial to the Chinese suppliers as well.
- [16:00]
A
You bring a very interesting point that the stronger yuan and weaker dollar actually are conducive to rebalancing the economic structures on the both sides of both China and the U.S. yes, I think that's a very important point. And you mentioned about bringing up the domestic side of the economy. And to extend that discussion, I think it's fair to say that if you look at the data year to date, the domestic side of the Chinese economy I would say is largely stable in a good way. One thing which is interesting though, is that analysts have been recently talking about green shoots in the Chinese property sector. More often or more broadly, the Chinese economy, for example, there are more talks in the investment community, especially within the analyst community, that to focus on the increase in both prices and transaction volumes of the secondary home market in Shanghai and a couple of other first tier cities. Now, to be clear, other cities in China are still facing a very stubborn problem. A very sluggish Property market. But my question to you, how is, should we see this as the beginning of a recovery trend which may broaden out, or you think we may be seeing growing divergence between the Tier one cities and the others, at least for the rest of the year?
- [17:18]
B
I think it's a rebound. Firstly, in the past few years, in the first quarter of the year, we all seen a decent rebound, especially in 2023, right? So we actually seen a very significant rebound in the first quarter of the year, measured in price and also measured in transaction volume. But then for the full year, we're still down significantly. So I think after falling for six years consecutively in a row, the Chinese property price is due for rebound. And also these days, the newer constructions, they are very different from the existing homes that people used to buy in China. For example, in Guangzhou, we're talking about the actual size that you get to use after moving in is about 140% of the designated area in the contract, right? So the actual usage area is substantially larger than before. Back then, when you buy 100 square in China, you only get 70 to 80% of the actual usage area because much of the area are common areas. And so therefore you don't get 100% of the area that you pay for, but these days you get 140% of the stuff that you pay for. So in that sense, the new construction, the unit price is like more than 50, 60% down from the peak. And as such, it's really a good news for home buyers these days. So I would say that given the price adjustment and also given demand for urbanization is still here, and also many of the Chinese are still living in an older house that is probably more than 30 years old, the demand for living quality improvement is also there as well. So I think as such, one shouldn't be too surprised to see a rebound in the property sector. And then actually, I think in the earlier episodes this year, we actually did discuss the likelihood of a technical rebound in the sector this year. But that doesn't mean that the sector has found its bottom. The reason being there's a significant inventory overhang in the marketplace, especially the secondhand housing. So there are so many of them in the marketplace. So when there's a price rebound, then quickly you're seeing a huge new listing of secondhand housing in the market. So it is very difficult to avoid thinking about the inventory overhang when we talk about the bottoming of the Chinese property market. So I think because of that, this year, even though we're likely to have a rebound to completely resolve the housing situation. Probably we're still a few years, at least a few years off.
- [19:43]
A
I guess there's still a bit of difference between the one year view and the five year view, so to speak, in any way. We've talked about a lot of things today. We talked about AI trade and semiconductors. We've discussed the China market, the economic outlook, including property. But before we finish this episode, we should definitely touch on oil and the Middle east situation and how you already talked about a little bit of that already. Now you mentioned in your previous episode that the worst is probably over for the Middle East. So far, if you look at how things pan out, it does seem to pan out this way. But what I found interesting is that the global markets, I think including China market as well, they seem to have become less sensitive to the changes in the Middle east situation. Simply put, oil prices are still at relatively high levels. But the equity market, especially the global equity market, seems to have looked through the economic impact already. So my question to you, how is has the market really moved on from all these already and then on the reverse if oil prices fall in case the US and Iran eventually reach an agreement? And so far we have some positive headlines over the past one or two days. Will this still be a positive catalyst to the market if the market hasn't cared about oil price spike at the beginning?
- [21:01]
B
Yeah, I think oil price going down is still good news for the market now. I think right now the market brushing off this higher price is because even though we are drawing down inventory at fastest pace in history, people are thinking that once the strait is reopened, then the oil that is stored on the oil tanker that is parked in the Gulf region can start to flow again. And that would immediately offset at least some of the gap between supply and demand in the market. And also given that the end of the war is certain, right? So all wars have to end one way or the other, either by one country conquering the other or by they settle down for some peace agreement. And I think now we're increasingly close to the resolution of a peace deal. Once that happens, then you should see at least the oil start to flow again. And also some of the refinery would be back online within three months. And if so doing what we are missing or what we've burned through is some of the strategic reserve that we built in the past few years when oil prices like 40 bucks ish, we're actually getting rid of some of the lower price inventory. I think in the longer term people probably realize that oil would probably in oversupply situation because now there are many other forms of energy supply. For example nuclear, the new energy revolution that China is going through that basically lead to to a situation that China now only use oil for 20% of its energy consumption. So China is not like before that is dependent heavily on imported oil anymore. And for every 100 cars sold in the Chinese passenger car market, well over 50% of it is new energy car. And now China is introducing new energy trucks as well and new energy bus as well. So all of these new initiatives as basically reducing the dependency on oil and also making high oil price less detrimental to the global economy. And if so, then the market might be right even though the oil price is still 100 bucks. Plus the market is looking through that because the end of the war is almost a certainty. And also the coming down of the oil price because of the new energy revolution and also because of the long term oversupply picture of the oil industry are still in place. And then on top of that you're looking at the semiconductor companies that is selling out two, three years of their production capacity. So basically the earning visibility is very certain and also you can calculate how much money these companies are going to make in the next two, three years. And if so, then earnings is also quite certain as well then plus watch probably get to the point smoothly. But even he can't increase interest rate immediately and probably he has to maintain the current interest rate level or even cut for his first major move because you can't simply reduce your balance sheet size and then at the same time hike interest rate. So that's just unthinkable to me at this stage. So all in all you're seeing oil prices no longer a menace to the market. Fundamental is very certain because the chip companies sold out their capacity for two, three years and also monetary policy is also relatively visible as well. Then I think the market is happy as it goes and in the months of May and June should be very positive for global markets.
- [24:38]
A
Well, that's very encouraging to hear and let's hope for the market going even higher. But 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.
- [24:54]
B
Thanks Richard.
- [24:58]
C
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