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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 Bank Julius Bear. It is great to have Peng 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 the time speaking with us today.
- [00:27]
B
Thanks, Richard. Great to be here.
- [00:30]
A
Let's start with the geopolitical situation today. Right now, the global markets and assets are all essentially priced on this one factor, which is the military conflict between the US And Iran. And even for the Chinese market, I think the same is true and frankly, nothing else matters. Today is the 9th of April, and that's one day after the US and Iran got into their ceasefire agreement. And of course that triggered a fairly strong rebound. Yesterday, for example, in China, both the Shanghai Composite and the Hang Seng index rose about 3%. Japan and South Korea gained 5 to 7% and then S&P 502%. Meanwhile, we've seen gold rebounded, oil prices plunged, the US dollar weakened, and at one point the dollar fall below 99 level. But having said all these this morning, which is only one day after the ceasefire agreement was announced, Iran accused Israel of violating the ceasefire and the Strait of Hormuz remains largely blocked. So it does look like to me that this ceasefire agreement is, to be frank, extremely fragile. At Jules Bear, we've been recommending our clients not to overreact to geopolitical headlines. Take a more prudent wait and see approach simply because President Trump has a history of a few U turns before a deal is made. And indeed, if you chase every single headline this time, the chance is that you kept falling behind the momentum and lost a lot of money. Okay, coming back to now, how at this current level, what is your assessment of the risk reward of the market? Is the market attractive? Would you chase? And equally importantly, what's your assessment of the geopolitical landscape from here?
- [02:15]
B
Firstly, I'm not chasing this rally. I think the war is actually de escalating, that is for sure after yesterday's ceasefire agreement. But I think there's a third party or many parties, more than two involved, you know, which is Israeli and also the Middle Eastern countries as well. So these are interest groups of different objectives. They have to pursue their own purpose. For example, Israeli is seeing Iran as one of its biggest enemy and therefore is trying very hard to diminish the enemy power. And then at the same time, the US really want to withdraw from the situation because the war is getting very expensive. And also the high oil price is seeping into inflation expectation of the US and binding the hands of the US Fed. And also I'm pretty sure that Trump is under very severe political pressure to stop the war. And also Iran really want to get out of the war as well because the country has been under severe attack and many of the facilities, oil and gas facilities, have been damaged. And also both sides, especially Iran, probably is running out of missiles to launch. So I think for US and Iran, they really do have an incentive to back out of the war. And also from a recent news coverage, you can see that Vice President Vance, he being one of the supporters for peace, is getting more coverage, which is a sign that the US side really want to deescalate the situation, even though Trump is still sending out tech hole tweets every now and then trying to exert continuing pressure on the Iranians. So I think the US and Iran really want to deescalate the situation. But then Israeli seems to be pursuing an entirely different objective. So maybe the war is de escalating from a full on confrontation between two major military superpowers into a regional conflict between Iran and Israel. But the upward pressure on the oil price would still persist. And if oil price stay high, stay elevated for some time, then it would start to affect the global economy and also global markets. And judging from the fact that the US market is only down 5% from the peak, while the news is not getting any better, I would say that much of the best situation is still not in the price. So I would say that the war is de escalating, but I think the impact on global economy and markets has not de escalated.
- [04:43]
A
Gotcha. To look back over the past few weeks, there's one thing that's worth pointing out which is that a few big trends that have lasted for a few months until this war and the market has shown some signs of reversal. And good examples obviously are gold and the dollar. If I'm to explain this, I think on one hand this basically reflects some investors taking profits, liquidating their gold holdings. But on the other hand, if oil price indeed is higher for longer, I think it's fair to say that central banks probably may slow down the rate cuts or may even flip to rate hikes, and that does logically drive the dollar to strengthen and gold prices to drop. In any case, the bigger question is has this longer term trend of dollar weakening and gold prices strengthening or going up changed? At Julius Bear, our answer is no. We Think the trends have not changed and actually is a strong view from us on this question. For example, there are a couple of long term trends that would likely last weaker dollar diversification out of the US Et cetera. Those have not changed. Now I guess my question is how in your opinions, what would be the factors that you would watch to determine whether these long term trends stay intact or not?
- [05:59]
B
Yeah, I think gold price is going to continue to go up in the longer term even though it has some recent setback, especially after the war started. There are a few things that has been driving gold price in the near term. Firstly is that in the month of January, gold price actually shut up $1,000 an ounce. And the speed of acceleration is unseen in recent history. So a parabolic surge in asset price normally lead to a parabolic plunge in in asset price as well. So I think being the best performer of all asset classes in the month of January, it's been one of the reasons why gold price suffer some technical setback in the near term. And I think secondly, since the war started, some emerging markets currency has been under attack. For example Turkey. The Turkey lira has been under severe pressure and keep making new lows versus the dollar. And so the Turkish central bank has to liquidate some of the gold reserve to defend its currency. So when a paper currency is in trouble, the central bank has to liquidate gold reserve to save it. Which means that gold is the last savior for paper currency credit. And so as such, I think the case for gold price to go even higher from here is stronger rather than weaker. And this is not the first time the US central bank sold off its gold reserve to save the currency. It has happened at least two other times in the past three years years. And one shouldn't be surprised to see the Tilly central bank sell some more gold reserve in the future. Now the thing is that because such incident actually strengthened the case for gold as a savior for paper currency, rather than gold's stories ending and all that. And also there was a narrative in the market circulating about how central banks are liquidating their gold reserve or they're not buying gold anymore, which simply is not the case. So the central bank selling gold to save paper currency. According to yesterday's official number, the Chinese central bank actually increased gold holding for the 17th month consecutively. Which means that as such price 4000 niche. The attraction of gold to the Chinese central bank is stronger, not weaker. And I think Chinese central bank is the major central bank to work in the world economy besides the US Fed. So I would say that yeah, longer term the case for gold is actually stronger, not weaker. But in the near term though, because gold and silver prices has been gyrating violently. For example, on the second day of the war to last week, at one stage gold was down 13, 1400 US dollars an ounce in a matter of a couple of weeks, which is epic as well. And so one shouldn't be too surprised to see some speculators want to profit from such epic volatility. Now the thing is that when you want to profit from such volatility, you have to have an edge. Either because you can gain first hand news faster than market consensus, or you have a different and right perspective about where the war is heading. So unless you have such edge, I would advise against trying to profit from gold's price volatility for long term investors. For asset allocators, they should focus on the long term fundamental stories for gold, which I think has become even stronger, not weaker during this war.
- [09:21]
A
I think it's always interesting that for this kind of trade it's really hard to make money in the short term, especially in view of such an extreme volatility. I guess for long term investors, they always need to almost tolerate the near term volatility if they want to make the money long term. Anyway, that's goal. But if we look at some other assets, there are also interesting observations. For example, let's come back to Chinese market because as we review the market performance last month, I think it's fairly surprising that the Chinese market actually has fallen relatively less. Historically, when the market falls, we generally see Chinese market being a higher beta. That is they would react much more violently. But this time it's the opposite. And let me just read out a few numbers of the US dollar returns of the different markets. In March The S&P 500 fell 5%. Han Seng index declined 7%, CSI 300 down 6%. Europe on the other hand fell 10%. In US dollar term. Japan 14, South Korea as much as 23. Now of course one can attribute this to the relative underperformance of the Chinese market in January and February. It didn't really go up following the other markets in the region. So now in return when the market fell, it doesn't decline as much. However, some also point that the Chinese economy may be more resilient to higher oil prices than people may have realized. I don't know whether that's true or not, to be frank. So my question to you how is, how should we assess the vulnerability of the Chinese economy to High oil prices at least compared to the others.
- [11:02]
B
I think China is weathering the storm relatively well. So I think it's reflected in the asset price, the market's performance as well. But then having said that, I don't think any economy in the world can escape from the impact of high oil prices. Even for the us it has a very well developed shale gas industry. And ever since the shale gas revolution, the US has become a net oil exporter rather than importer. It fundamentally changed the landscape for the us. But then even so, we are seeing the gas price at the pump in the US is surging up to $5 and up. You know, it's almost double since the beginning of the war. Because oil price is likely to stay elevated for some time as we previously discussed. Therefore inflation expectation is bound to change, right? So if oil price stay elevated for some time, I think inflation expectation, which is the focus of Fed's policy, is going to change. Just imagine the US Fed has to tighten policy at times like this when threats in the economy starting to emerge. So it cannot be good news. And as for the other countries, for example, Japan has a very large strategic oil reserve. It is estimated that it has more than 200 days of oil reserve in its bank. So Japan can start releasing barrels of oil into the market trying to suppress the domestic price. But what would happen after 200 days? So what if the Hormuz navigation is not back to normal after 200 days? Then I think we'll be running the risk of complete shortage of oil. And then at the same time, when you release the strategic oil reserve, then you have to replenish the reserve at substantially higher market price, which I think increase the cost of running the economy as well as as for smaller countries developing emerging markets, such as Pakistan, for example, 100% of its energy is imported. And therefore I saw a report saying that Pakistan is actually running out of oil reserve in a matter of days. Many of the gas stations in Pakistan is starting to ration the amount of oil each customer can buy. I think the situation is quickly deteriorating, especially for those countries who rely on oil exports and also have very limited strategic reserve. As for China, I think it's in a much better situation in the sense that in the past 10 years China has been developing the alternative energy source very aggressively. And these days alternative energy installation capacity as a percentage of new installation is well over half. But even China is still an economy that is relying on fossil traditional energy because this is the most reliable dependable energy source that you can have. Just imagine running Everything on solar power and there's continuously couple of weeks of cloudy days then you could be in trouble because the storage of power has not been completely resolved yet at this stage. The alternative energy generation technology is far more advanced than the storage technology. So I think this is one of the opportunities for investors in the future. But for now, traditional fossil energy is still a very important power source for China. And China actually has a very large strategic oil reserve as well. But it still cannot escape the impact from high oil prices. So I would say that yeah, I think China is weathering the storm relatively well. But if high oil price persists and stay elevated for an extended period of time, then I think the global economy would be in trouble.
- [14:58]
A
So no country is immune. But I guess I agree with you on the positive note, that might accelerate the development of the renewable energy and that could be definitely a long term investment opportunity, not just only for China, Europe and US as well. Talking about China, I think it's fair to say that not a lot of investors are really looking at China factors when they trade China in the recent few weeks, especially since the Iran war started, because I think we would all agree that the entire investment community is basically just looking at the Middle East. But what's particularly interesting is that a few data points are showing some green shoots in the Chinese economy, if I may say. For example, the PMI data released last week showed that the manufacturing, the non manufacturing and also the composite index all went back to about 50, basically the expansionary zone. This is a positive sign for economic momentum. Meanwhile, the property market had a decent rebound in March. Both new home and second home sales are strong and home prices seem to find some support. Now I don't know whether this is temporary, whether this is seasonal or indeed something good is happening. So my question to you, hao, is you do a lot of research on the Chinese economy. What's your view this time? Do you think the Chinese economy is really coming back or you think you need a few more data points to confirm?
- [16:22]
B
No, I think in the first quarter this year the Chinese economy performing much better than thought. As you said, PMI is back to expansion territory and also real estate is showing signs of life, new home sales is picking up and also export sector is firing on all sectors and therefore one can say that the economic performance in the first quarter has been very well. But having said that though, I think the performance is very strong because there's a lot of money being spent since December. China is trying to front load the physical spending, in other words. So I Think because of all the spending since December, therefore it translates into a relatively well and strong economic performance. So you can say that it's seasonal because much of the money and much of the credit growth tend to be happening in the first quarter of the year. So that you have three more quarters a full year for this money to show its impact on the economy. So I think it's all good for the first quarter, but then it also present continuous challenges for the rest of the year because you can't expect to continue to spend money at this speed like you did since last December. So while we applaud the strong economic performance, but then at the same time we are also circumspect that economic growth rate could decelerate from here and the economic cycle is entering into a sort of a second half or second half of the second half. And therefore one should be aware of the potential risk that economic growth pace could slow down from here. And also just now we talked a lot about the impact from the war, especially how the high oil price is going to affect the global economy. And China being the second largest economy in the world will inevitably fuel the impact of high oil prices. So I think we need to be careful when we look at the set of numbers. And also the export sectors in particular has been very strong in the first quarter and beating all expectations. But then going forward, because high oil prices is going to affect global demand. So even though the Chinese exports has been well and also the quality has been very strong despite a rising appreciating Chinese currency, which means that the Chinese exports has been very competitive. But if global demand is slowing down, then inevitably it will affect such an important growth engine for Chinese economy. So yeah, so I think while we are happy for the first quarter, but then we remain cautious for the rest of the year.
- [19:05]
A
Okay, I think you reminded me a very interesting pattern in which for the past three or four years it's been fairly consistent that the Chinese economy often had a very good first quarter. The strength may last into, let's say April and May and then the economy starting to weaken, decelerate. It feels like we are following the same pattern again. And I think it remains to be seen whether that's stimulus driven, export driven versus whether there's indeed some organic improvement in the domestic demand, especially on the consumer side. So far we've seen one or two positive data points. I would say I'm trying to spin some positive story for Chinese economy. So for example, Moutai raised prices, raw milk prices seems to be stabilizing domestic Tourism data during the Qiming Festival were quite decent. I'm thinking it from a sector rotation perspective because you probably have seen that the new economy or particular new consumption stocks have not been doing very well. And as the liquidity looking for place to park, would it be a reasonable assumption or expectation that some of these old traditional consumption stocks may start to attract money into them? And what's your view on the traditional consumption from a sector allocation perspective?
- [20:22]
B
Yeah, I think consumer staples should perform well because since beginning of February, right before the Chinese New Year, we have been navigating defensive rotation. We're telling people to be on the cautious side and cut down their leverage in the portfolio and also lower the risk exposure in the portfolio as well. So far the call has been playing out. Now back then we didn't know that the war would start. Nobody knows. Right? So if it were not for the war, it would be some other factors that would make the current defensive rotation acceptable or plausible for many of the investors. Now I think as for the staples. Right. So in a Western sector classification, Moutai, one of the most famous Chinese liquor brand and a super premium brand, I would say should be classified as alcohol and tobacco sector, which is part of the food sector and therefore is the consumer staple sector. But in fact, Moutai is a barometer for the health of the Chinese economy, especially for the discretionary spending side because China has a very large ceremonious road in celebration during Chinese festivals. For example, during the Spring Festival or the Qingming Festival, when Chinese families get together to celebrate the moment, they tend to open a bottle of Moutai, which is the most expensive Chinese liquor on the market. It's for special occasions. So I think each bottle of Moutai can sell for up to 2,000 yuan a bottle, which is more or less the same as a bottle of Remy Martin Xor. So I think a lot of people tend to think that, oh, Moutai is a staple according to Western sector classification, but it is indeed a consumer discretionary sector. So there are many nuances that we have to be aware of. And also, for example, stocks like Labubu, which is a really good strong long term story. But then because the stock price has grown so much and also Labubu was all the craze in the last two years and in the most recent earnings quarter, people start to question Labubu's growth potential going forward because the growth rate clearly has been slowing down. And then also their counterfeit Labubu surfacing in the Chinese market as well. So when it comes to investing in China, there is a lot of nuances that people have to be aware of. So when we're talking about consumer staples, we're probably talking about the more mundane plain names without much stories attached to it. I would say that yes, the staples will continue to perform. I think Moutai is picking up temporarily because economic performance in the first quarter is very strong. Infrastructure spending is up and also the real estate sector seems to be picking up as well. And being a consumer discretionary name, they tend to be more sensitive to such positive change in the Chinese economy. You know, you can see that in the first quarter of this year, especially after the war broke out, the value factor in the portfolio tend to perform much better than the growth factor. So if your portfolio is heavily growth tilted, then it tends to underperform rather substantially. So I think for the next two quarters at least, we're still advocating a cautious stance, we're still advocating defensive rotation. We are looking at consumer staples, healthcare, utilities, to weather the storm. Especially now, the outlook of how the oil price is going to affect the global economy is still largely unknown.
- [24:03]
A
And I think one related concept or theme of value, there's always a lot of overlap, especially in the Chinese market with dividends because a lot of dividend stocks are maybe value stocks as well. And the first sector that I can think of is Chinese banks. What's your view on Chinese banks? Do you think it's worth holding on? There's a lot of time it could be a buffer to volatility in the Chinese portfolio. I don't know. What's your view on that?
- [24:27]
B
Yeah, I think we like Chinese banks. On one hand, the Chinese bank's relative performance has been near its all time low and it should start to repair from there. I think on the other hand, many people will worry about whether there could be some banking problem in the banking sector because the Chinese property price has gone down almost 40%. Right. So some of the bank loans tend to go sour and therefore there could be asset impairments, asset write downs. But I think many people misunderstood the role of Chinese bank in the Chinese economy. They are too big to fail. Basically it is the cornerstone of Chinese economy. So I think for many of the loan portfolio problem that the Chinese banks are facing, you know, as long as they don't mark the asset price to market, then they could somehow muddle through this difficult period. And also, you know, because according to the National Asset Management rules, it actually require Chinese banks to give out constant dividend to the State Department. So therefore common shareholders would benefit from such a rule as well. A lot of people didn't realize that for the Chinese banking sector, you know, the interest margin is protected by Chinese law. Not everybody can open a bank. If you want to open a bank in China, you have to get a license. You get an approval from CBRC and such approval process to obtain a banking license is actually license to print money in the sense that your interest margin is protected by law because the PBOC sets the lending rate and deposit rate for the banks. And there's always a gap between the deposit and lending rate. So you know, getting a bank license in China is just the license to print money. Think about this. If you're a Chinese investor in the mainland market, you have 5,500 stocks to choose from in the past couple of years. The growth stocks like the Chinese Board and the New Tech Board, producing mega stars that rise 10, 20 times, sometimes even 100 times. So they are stellar performers in any portfolio and it makes a lot of people very rich. And I think from a human psychology perspective, such stellar performance naturally attract a lot of attention to retail investors and also a lot of money as well. And therefore the banking sector tend to be languishing and getting out of people's focus when building a portfolio. So who would be the natural buyer for such large index component with huge market cap? It has to be the national team, isn't it? So the banking sector naturally becomes a market stabilizer when the national team want to stabilize the market indices. So as you can see, if high oil price continue to affect global economy, if the market continue to be volatile, when the outlook of the world is still uncertain, even though it's de escalating, you can imagine the role of the national team in the banking sector that. So I think without doubt the Chinese banks will once again become a market stabilizer because the national team is a natural buyer for such large cap stocks. And also these banks are still giving you 6% dividend, which is very decent in a market where you only get 1 to 2% cash yield from your cash management account in China. So I would say that, yeah, I think banking sector should be part of the considerations when investors build a portfolio trying to weather the storm from the war.
- [28:02]
A
Right? We agree with you. We also have a positive view on Chinese banks, especially from a dividend perspective. And you gave us a lot of things to chew on. Value stocks, defensive stocks, dividend stocks. I think plenty options for our investors to think when they decide on what sectors to allocate within the China portfolio. That's pretty much all we have to discuss today. Thank you very much HAO for your sharing, ladies and gentlemen. Thank you for listening and stay tuned for our next podcast. Goodbye and speak soon.
- [28:32]
B
Thanks Richard the information and opinions expressed
- [28:37]
A
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