Value Investing Evolves Amid Shifting Landscape

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This week, the A-share market in China mirrored the fluctuations seen in global capital markets, albeit with a relatively lower degree of volatilityIn stark contrast, markets abroad, particularly the Japanese stock market, experienced dramatic swingsOn Monday, the Nikkei 225 index plummeted by an alarming 12.4%. However, by Tuesday, it managed to rebound significantly, soaring by 10%, which prompted the activation of a circuit breakerIn times of market panic, the primary catalyst for this downturn was the Bank of Japan's unexpected shift from its habitual stanceOn July 31, the central bank decided to raise interest rates for the second time, increasing Japan's key interest rate from a range of 0% to 0.1% to 0.25%. This marked a departure from the long-maintained low and even negative interest rate environmentAlthough the new rate of 0.25% is modest, it caused significant market turmoil owing to the longstanding expectation of negligible rates

This led to a rush of unwinding hedge trades, causing capital flight from the marketThe appreciation of the yen further fueled investor fears regarding diminishing profits for Japanese export firms, leading to a steep decline in the stock marketOn August 7, the Vice Governor of the Bank of Japan stepped in to reassure the market, indicating that there would be no interest rate hikes during this period of volatility, and subsequently, stocks throughout the Asia-Pacific region began to recover.

Following the change in the Bank of Japan's policy, the tumultuous market conditions of Japan saw a partial recoveryYet, on Monday, when the Japanese stock market was in free fall, investor sentiment was driven by fear, which sent stock prices tumbling and ignited a global market retreatThe unexpected interest rate hike by the Bank of Japan triggered waves of yen carry trades to unwind, and concerns about a potential recession in the United States sparked wider volatility across the global markets.

Recently, the United States revealed that its non-farm payroll statistics fell drastically short of expectations— a rare occurrence over the past two years when employment figures were historically robust

However, the data for July indicated a notable downturn in job creation, compelling U.Stech stocks to descend sharplyPreviously, these tech stocks had been on a winning streak, experiencing substantial growth; now, many have retreated over 25% from their peaks, especially as some reported second quarter earnings that failed to meet forecasts, with stock prices plummeting by over 20% in just one dayJust last Friday, the U.Sreported its July unemployment rate, which rose to its highest level in nearly three years, triggering a critical economic recession indicator known as the Sam RuleThe creator of this rule mentioned that while recent economic data is disappointing, the Federal Reserve does not necessarily need to slash interest rates urgentlyHowever, the Fed does have ample justification to lower rates by 50 basis points.

Despite the Federal Reserve's intention to exert downward pressure on the U.S

economy via interest rates, Sam has cautioned that the Fed should not delay too long in making cuts, as adjustments to interest rates take considerable time to impact economic dynamicsBefore the unemployment figures and the resultant stock market downturn, market analysts had projected a 95% probability of a 25 basis point decrease by the Fed in SeptemberHowever, that forecast has shifted dramatically, with predictions now indicating a possible 50 basis point cut, with a probability jumping to 75%. This aligns with our earlier assessments discussed at the China Chief Economist Forum, where we noted that the deceleration in the U.Seconomy, combined with the Fed's more than year-long maintenance of high rates between 5.25% and 5.5%, could soon compel them to actIt appears that the first rate cut could be initiated in September, with subsequent cuts of 25 basis points potentially occurring in November and December

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If the U.Sstock market were to plummet within the month, this could expedite the Fed's decision-making processA direct 50 basis point cut in September would put the Fed's total cuts for the year at 100 basis points, inevitably resulting in currency appreciation for non-U.Scurrencies.

Recently, the renminbi has experienced a rapid appreciation against the dollar, reflecting growing market expectations about the Fed's future movements.

However, there is a chance that the Sam Rule may become less valid due to changes in labor dynamics following the pandemicA notable influx of new entrants into the labor market has contributed to an increase in the unemployment rate that is not solely attributable to economic slowdownNevertheless, the triggering of the Sam Rule serves as an important cautionary signalPreviously, stock markets in Europe, the U.S., and Japan had demonstrated a bullish trajectory but now show signs of a top-side retreat

Many investors are left wondering whether a shift will occur, dubbed "the East rises while the West falls," implying that retreating markets in developed Western regions may lead global capital to seek new investing opportunitiesGiven the current context, the A-share and Hong Kong markets stand out as two attractive investment landscapes, potentially attracting funds escaping from European, American, and Japanese equitiesThe Hong Kong market, being entirely open, stands to benefit from incoming capital, leading to a potential recovery in valuationsYet, we have observed a generally weak performance in the A-share and Hong Kong markets lately, indicating that foreign investment has yet to begin in earnest, largely stemming from investor confidence issues.

On a more positive note, there are signs of recovery in the education and training sectorNotably, a well-known U.S.-listed education training enterprise reported a significant profit surge in the first half of the year, indicating possible market revitalization.

Boosting high-quality consumption fundamentally hinges on improving residents' income levels

This is a viewpoint I have consistently emphasized—enhancing wage and asset income can enable consumers' financial capacity to rise, thereby stimulating consumptionFurthermore, local governments, when endowed with sufficient financial resources, can promote consumption through issuance of vouchersSuch measures can allow consumers to purchase goods at discounted rates, consequently unleashing potential spendingHowever, it remains paramount to raise residents' incomeChinese investors presently face limited channels for investment, primarily confined to either the real estate market or the stock marketTherefore, invigorating performance in the real estate sector, coupled with stability in the stock market through increased intervention from state funds, could strategically shift market trends from a downtrend to an uptrend, restoring investor confidence.

After enduring three years of declines, many quality stocks have been significantly undervalued, including those with stable performance histories that now face substantial drops in share prices

Consequently, when a market correction occurs, a surge of external investment volume is anticipated as core assets previously experiencing major downturns attract renewed interestWhile some may contend that value investing is no longer effective, such an assertion is misleading—it echoes a prior period when blue-chip valuations were excessively inflated and several sectors witnessed declinesThe cyclical nature of various industries suggests that stock prices can experience dual declines due to diminished earnings coupled with reduced valuationsIn essence, even strong sectors may experience transformations necessitating dynamic valuation assessmentsFor instance, real estate, traditionally a fast-growing sector, has underperformed significantly recently, placing considerable strain on its associated supply chainThe liquor sector serves as another illustration; although it has also experienced effects from consumption downgrade, it remains fundamentally strong

Despite a fall in stock prices, the investment value of leading liquor enterprises remains intact, reflecting their robust and stable growth potential despite an overall downturn in consumptionNotably, market shares of leading brands may actually increase amid a decline in overall beverage consumption.

As we engage in value investing, the selection of quality companies to hold is criticalWhile the definition of a "good company" remains subjective, certain criteria universally apply: a good company consistently creates shareholder values, and its management is adept at maximizing profitsStrong profitability and healthy cash levels alongside low debt ratios are essential characteristics of these companiesWarren Buffett's benchmark includes a Return on Equity (ROE) exceeding 20%, paired with a debt-to-equity ratio below 30%. These attributes facilitate a company's resilience during economic downturns and their eventual recovery in subsequent positive market conditions

Long-term, stock prices naturally oscillate around their intrinsic value; however, human psychology can cause these prices to be severely undervalued or to inflate during bubblesWhen the market experiences irrational sell-offs, those prices can drop excessivelyIt's during these downturns that investor conviction becomes paramount—having the courage to strategically invest when the market is down can position one favorably for the next uptrend.

Recognizing that stock prices operate in cycles, questioning the value of investing during cyclical lows serves little benefitOnce the subsequent market cycle emerges, stock prices invariably ascend to new highs, underscoring the potential for significant returns on early investments in quality companiesNonetheless, I must emphasize that investors should continually reassess their industries and investment targets as they evaluate operational performance, profitability, and valuation metrics