Minority Asset Management Liam Zhou: A new round of wealth creation cycle will be born out of the crisis, and you need to be present.

Minority Asset Management   2022-10-14 本文章113阅读

Every bull market starts from multiple blows. The escalating Russia-Ukraine war, the rocketing US inflation, the swinging global forex market, the weak domestic consumption during the long holiday week, and the increasing covid cases, all these bad news took turns to torture the already fragile nerves of the capital markets. CSI300 index touched 2-year low while Shanghai Composite Index went under 3000 for the 49th times in its history. However, the new round of wealth creation cycle is quietly in the making during these darkest moments.


Summarizing the past 30 years China A-share performance data, the following five market-bottoming signals are gradually taking shape. No one knows the exact day when the trough will be reached, but it is possible to estimate the market is about to bottoming out.


1)   The new equity fund issuance

From a behavioural finance perspective, new fund issuance reflected the prevalence of the herding effect. It is a great inverse indicator. When fund managers feel it is very easy to issue new fund, it is usually the difficult time to deliver good performance. Vice versa, when difficult to sell new fund, it is relatively easy to produce high returns. When everyone is making money near the market peak, capital inflow is enormous. The peaks of the last two bull markets, May 2015 and Jan 2021, were both marked by record high new fund issuance. In May 2015, the new fund issuance was 300bn Rmb, and in Jan 2021, it reached 500bn Rmb. When it is near the real bottom of the market cycle, rarely anyone is brave enough to subscribe to new equity fund. The troughs of the last two bear markets, end of 2012 and 2018Q4, were both matched with record low new fund issuance. In Sep 2022, the combined issuance of new equity and multi-strategy funds was less than 20bn Rmb, close to the level we saw in 2018Q4.


2)   The turnover ratio

The turn-over rate reflected the confidence level of the market participants. When the market is near peak level, the turnover ratio will be high, and vice versa. 1trn Rmb daily transaction volume means 1trn Rmb of buying and 1trn Rmb of selling happening at the same time. Both sides of the trade think themselves are right. The money-making effect reinforce the overconfidence and hence the turnover ratio. Whereas the market is at low, there is few overconfident market participants, resulting in low turnover ratio. During the heydays in 2015Q2, the daily turnover ratio of China equity market reached 10% of total free-flow market cap. In other words, the total A share free-flow market cap changed hands once every ten days. This ratio gradually came down and was at 1.3% level at the market trough at the end of 2018. The average market turnover level has been on the rise in recent years due to the increase of quantitative trading strategy, and it rebounded back to 3.3% in Sep 2021. That being said, the daily turnover ratio of A share market is now at 1.8%, the lowest point over the past two years.


3)   Valuation level

Valuation reflected the level of optimism or pessimism that investors have for companies’ future. Valuation level is a better gauge of whether the share price is cheap or expensive than the stock index. When the valuation is high, the investors are very optimistic about the future, and it usually takes place when the market is at its high. When the valuation is low, the investors are pessimistic about the future, and it almost always happens when the market is at its low. The PE levels of big-cap growth, small-cap growth and small-cap value stocks are all at two-year low, while the PE level of big-cap value stocks are at 7-year low. The pessimism indicated by these valuation levels are comparable to that of the end 2018. But the most pessimistic moments are also the window opportunities for the best risk-reward investment. Any relief of pessimistic sentiment will propel the market to go up.


4)   The equity-bond yield gap

The equity-bond yield difference reflects the investors preference between equity and bond. When fixed income products have higher yield, more liquidity will flow in. In recent years, the fixed income yield has been declining, while the average dividend yield of A-share stocks has been rising, even though dividend yield is just a part of overall equity investment gain. The current average dividend yield of A share market is at 2.1%, 63bps lower than the 10-year Chinese government bond yield, smallest gap in three decades.


5)   The reaction to news

The market reaction to good or bad news reflects the fearful or the greedy sentiment. The previous four indicators were all quantitative indicators, while this one is qualitative in nature. During the market peak, any good news may trigger a stock price jump. But during the market trough, the market tends to ignore any good news, but overreact to any bad news. Recently, the market ignoring the government support measures announced to the property industry while sharp selling off on low holiday traffic number during the Oct National Day long holiday week was a typical case in point. We must remember what Warren Buffett said “be greedy when others are fearful”.


Trust indicators or trust your feelings when investing? Our emotion was constantly affected by market condition and by those who surrounding us, which usually is far from the truth. It’s natural to fear when others fear, and to be greedy when others greedy too. During the market peak in Feb 2021, everyone felt the risk was low and lots of money flew in. But when the market dropped to its two-year low at this moment, most people felt the risk was too high to buy. When investing, we must recognize that the feelings tend to be incorrect, indicators that were tried and tested in the past should be utilized in decision making process.


We need to manage the drawdown risk in the bear market, to preserve capital in order to participate the new round of wealth creation. The market condition of this year has been an onerous test on manager’s ability to control drawdown risk. Most of the specialist funds that bet on one specific sector have borne the full brunt of the market sell-off. Only when the winter comes, one will know if he has had enough clothes on. The ability to control the drawdown risk is critical to long-term accumulative return. If the NAV is down 50%, it needs to go up 100% just to recover.


You need to be present when the opportunity comes. It is normal to cut stock exposure or redeem equity funds this year when one is faced with so many negative news and investment loss. But every round of the bull market starts from multiple blows. Our funds effectively controlled the drawdown by a combination of low valuation, high prosperity and private placement strategies. Meanwhile, we will keep fully invested, be present, and not miss the beginning of a brand-new cycle.