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Understanding the Recent Stock Market Volatility

February 2021

Executive Summary

Chinese stocks had a strong, extended rally in the last twelve months, but underwent a correction recently, particularly in the high-growth technology sector that has outperformed in the past years. Investors were rattled by rising US bond yields which led to a global sell-off in tech and new energy stocks that has not spared Chinese companies. The sell-off in China was, in addition, triggered by Chinese regulators who tightened monetary policy and warned of “asset bubbles” in Chinese real estate and global stock markets. These moves reflect China’s ”normalizing” macro-policy and deleveraging, in contrast to other countries that continue to deploy generous stimulus packages. Furthermore, China, not unlike many other countries in the world, has started reining in the tech titans.

This cautious approach by the Chinese regulators will likely continue to result in short-term market volatility that will bring valuations in check, creating potential investment opportunities in the months ahead. Long-term, China’s fundamentals remain strong. Recently released economic indicators show 30+% growth in the first two months of the new year. The economy is well on track to reach 6%-8% GDP growth in 2021. Capital inflows are expected to increase given the strong IPO pipeline and newly piloted Wealth Management Connect.

Influx of capital had resulted in an extended rally and high valuations

The stellar performances of Chinese stocks and bonds have attracted global investors who have poured $900 billion into China’s capital markets. Mainland investors have also followed suit, driving PE ratios to a multi-year high of 21.9 in February this year. While this was lower than historical peaks (2009 PE 29.1, 2015 PE of 22.3), and lower than PEs of Nasdaq and S&P, many stocks that were investor’s perennial favorites, traded at high valuations.

Chinese moves towards “normalizing” macroeconomic policy

While most governments worldwide have deployed large-scale stimulus programs to jumpstart their economies, China is starting to normalize monetary and credit policy to avoid inflation and debt overhang.

That is because China already had a V-shaped recovery in the middle of last year and was the only major economy with a positive GDP growth rate in 2020 (+2.3%). With recovery gaining momentum, the People’s Bank of China (PBOC) focused on paring back stimulus and reducing leverage. The PBOC withdrew liquidity from the financial system, engineering the biggest cash squeeze since 2015. It also repeatedly warned against speculation in mainland’s property market, and “asset bubbles” in the global financial markets that had the potential to overheat Chinese capital markets.

In addition, Chinese government stepped up regulatory scrutiny on the “monopolistic practices” of the tech titans, censuring Alibaba and other internet platform behemoths. The regulators were also concerned with the fintech businesses of the internet giants. Consumer loans by these players are fast-growing and currently unregulated, posing a potential risk to the banking system. These measures reflect the government’s stance to take a stronger role in preempting risks to the financial system.

In parallel, across the world, global bond yields spiked on inflation fears, resulting in a sell-off of “frothy” tech and EV stocks in the US, as well as in China. The combination of surging global bond yields and Chinese regulatory tightening on a macro and microeconomic level, led to investors taking profits and causing a sharp market correction in February.

Volatility in the short-term, but strong fundamentals in the long-term

Going forward, Chinese regulators will continue to cautiously adjust monetary and credit policy in their twin objectives to 1) manage the risks of inflation and debt, against the need to 2) maintain steady economic growth. The regulators will also focus on curbing the excesses of private sector i.e., Internet companies that dominate the market, and mitigate fintech credit risks. This fine-tuning will likely continue to cause swings in the stocks market in the short to medium term.

Long-term, the overall fundamentals of China remain very strong. The recently released January-February data shows strong economic growth. Year-on-year, the value-added industrial output is up by +35%, retail sales of consumer goods by +34%, investment in fixed assets by +35%, and foreign trade by +32%. The economy is well on track to reach 6% GDP growth (conservative estimate by Chinese government) to 8% (forecasts by economists) in 2021.

In addition, we anticipate an increase in capital inflows to China, given the strong 2021 IPO pipeline. There are a number of highly anticipated mega IPOs (e.g., Megvii, Yitu, Didi Chuxing) as well as secondary listings of tech giants in Hong Kong (e.g., Baidu, Bilibili, Weibo, Trip). Moreover, the government is piloting a ”Wealth Management Connect”, akin to Stock Connect and Bond Connect. This will allow residents of Hong Kong, Macau and 9 provincial cit

ies in Guangdong (Greater Bay Area) to access wealth management products sold by financial institutions in the area. The Greater Bay Area is the wealthiest urban cluster in China and these 11 cities have a combined GDP equivalent to the world’s 11th largest economy (ahead of Russia and Canada).

These recent market developments create potential investment opportunities for the ACATIS QILIN Marco Polo fund, particularly as valuations have come down. We continue to adjust the portfolio to capture these opportunities in 2021. If you have any remaining questions, please do not hesitate to contact us anytime.

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